Reserve Bank to leave OCR on hold at 2.5% on Thursday, economists say; Euro debt crisis to be front-and-centre

Reserve Bank Governor Alan Bollard's eyes will be glued to Europe as he keeps the Official Cash Rate on hold at its record low of 2.5% next Thursday, economists say.

ANZ and ASB are both expecting the Reserve Bank to keep the OCR on hold until December 2012, while Westpac economists this week moved their forecast back from June 2012 to September at the earliest, and maybe as late as December. Meanwhile, markets are actually pricing in a fall in the OCR.

Domestic issues won't have any impact on the Reserve Bank's OCR view on Thursday, with a gradual recovery here not creating inflationary pressures enough to worry the central bank.

'Lower OCR peak'

Westpac economists Dominick Stephens and Michael Gordon said the main channels of contagion for New Zealand from the Euro crisis were likely to be through export prices and the cost of overseas funding.

"The real concerns are around the global economy, and in particular the escalating fears of a euro zone break-up, with a resulting wave of sovereign and bank defaults across the continent. While the situation is very fluid (and developments in the last week have been much more positive), it’s becoming clear that even the best case scenario will be one of poor global growth," they said.

"Europe is already heading into recession, Asian growth is slowing significantly, and the US is struggling to gain any real momentum. 

"In the last two OCR reviews the RBNZ has maintained a surprisingly constructive tone on overseas influences, even while acknowledging that “there is a real risk” that global activity slows sharply. But we think the RBNZ is set to significantly downgrade its world growth forecasts this time – the November Financial Stability Report, while not commenting directly on monetary policy, indicated as much – with the obvious implications for monetary policy," Stephens and Gordon said.

Meanwhile they expect the Reserve Bank to indicate a lower peak for the OCR than in September.

"Weaker world growth forecasts and tighter credit conditions could amount to a substantial change in the RBNZ’s interest rate projections compared to the September MPS. An eventual return to a normal level of interest rates will still be on the cards, but at a slower pace. We expect the peak in the 90-day rate projections to be shaved down from 4.3% to more like 4.1%, and the pace of tightening to be slowed relative to the September MPS (which indicated 140bps of hikes through next year)," they said.

Markets pricing in OCR cut

ANZ economists this week pushed out their first expected move in the OCR until late 2012.

"Of course Murphy’s Law could apply and aggressive collective action globally could remove current dislocations across markets.  However, to bank on action being a permanent solution as your central scenario simply seems a stretch. We expect the RBNZ to come to the same conclusion in the December Monetary Policy Statement next week," they said.

"Of course the NZ rates market is actively pricing an OCR cut so the spectre of slow and gradual hikes, though a long way off, is not market connected. We’re not concerned by this. Markets will be markets: they play a risk-return game, and if we see the OCR moving down it won’t be by 25 basis points.  It was only in July that the market thought the OCR could approach 4 percent by the end of 2012! 

"We’re relatively bearish regarding the global scene but are mindful of marketdriven swings and the support NZ is getting via a lower currency. In such a situation it’s the spirit of one’s view that matters. Pushing out prospects for a hike until late 2012 is really saying the OCR is going nowhere for a long time," they said.

'Domestic recovery very gradual'

ASB economists, who also this week began picking December 2012 for the first move in the OCR, said the Reserve Bank would focus on offshore developments. They said the domestic situation would change the Reserve Bank's outlook:

"Recent domestic developments also indicate little urgency for the RBNZ to raise the OCR. Recent housing market data indicate some slowing in the recovery in house sales in recent months. Meanwhile, credit growth remains weak, reflecting continued caution amongst households and businesses. We expect the recovery in household spending and business investment over the coming years will be gradual," ASB economists said.

"Core manufacturing activity growth slowed over Q2, following robust growth over the previous 2 quarters. The outlook for manufacturing remains relatively upbeat, and we expect to see continued, albeit more modest, growth over the coming year," they said.

"Inflation indicators point to continued breathing space for the RBNZ on the inflation front. Medium‐term inflation expectations and pricing intentions have continued to ease. Q3 inflation was below both market and RBNZ expectations. In particular, there was little sign of a pick‐up in construction cost inflation. To the extent the RBNZ has highlighted its concern that post‐earthquake rebuilding activity in Christchurch will boost construction costs and flow through to wider inflation pressures, the Q3 result will be of comfort for the RBNZ.

"The RBNZ pared back its growth forecasts at the September MPS, largely reflecting its expectation rebuilding activity would occur later next year. Domestic economic developments since then have been slightly weaker than September MPS forecasts. Given the large degree of uncertainty at the moment, we do not expect substantial revisions to the RBNZ’s domestic outlook. Instead, we expect the RBNZ will highlight the increased downside risks to the domestic growth outlook from recent offshore developments," ASB economists said.