RBNZ holds OCR at 2.5% as expected due to global uncertainty, modest local growth; doesn’t talk about future hikes

By Bernard Hickey

The Reserve Bank has held the Official Cash Rate (OCR) at 2.5% as expected and made no mention about future interest rate increases in its first interest rate decision of 2012.

The bank dropped any mention of a future rate hike from what had been described as 'emergency' levels late last year and has maintained that stance today.

The bank said the global economic outlook remained fragile, growth in the local economy was modest and inflation pressures were reassuringly well contained.

“Given ongoing uncertainty around global conditions and the moderate pace of domestic demand, it remains prudent to keep the OCR on hold at 2.5 percent,” Reserve Bank Governor Alan Bollard said in a statement.

The Reserve Bank makes an interest rate decision every six weeks or so, but only releases a full Monetary Policy Statement with a news conference once every three months. The next decision will be with the full March quarter Monetary Policy Statement (MPS) on March 8.

Economists expect the bank to leave the OCR, which is the basis for all interest rates here, on hold at its current record low until September at the earliest. Some are even now suggesting the OCR could be held well into 2013 because heavily indebted households are reluctant to spend and inflation remains subdued. Financial markets expect the RBNZ to hold the OCR until early next year, with the risk of a cut if Europe’s financial crisis worsens dramatically.

The US Federal Reserve said this morning it would hold its official rate near 0% until 2014.

Bollard said financial market sentiment had improved slightly since the bank’s December quarter decision, but the global economy remained fragile.

In late December the European Central Bank (ECB) lent 489 billion euros to European banks on three year terms at around 1%, which is credited with easing some of the tensions in European financial markets and banking systems. However, Europe’s economy is sliding into a recession or worse under the weight of massive government debt through much of Southern Europe. The International Monetary Fund warned this week the global economy faced a ‘1930s moment’ unless Europe took concerted action to boost economic growth.

“World prices for New Zealand’s export commodities have remained elevated, but the recent appreciation of the New Zealand dollar is reducing exporters’ returns,” Bollard said.

Funding costs

“The European debt crisis has also increased the cost of international funding, which will likely pressure funding costs for New Zealand banks over the coming year,” he said.

About a third of New Zealand bank funding comes from foreign banks and pension funds. Tensions in European financial markets over the last year have increased the interest rates for those funds. Although it is noticeable that bank net interest margins have increased over the last year as term deposit rates were held low and many mortgage moved to floating mortgages, which produce higher profit margins for banks.

Bollard said in December New Zealand’s monetary policy would have to take into account such an increase in funding costs. He did not repeat that comment in today’s short statement.

Some economists have suggested the Reserve Bank may have scope to cut the OCR later in 2012 to offset any increase in funding costs that might increase floating mortgage rates. Some banks have warned they may have to increase floating mortgage rates because of these increased funding costs, even if the OCR does not move.

Bollard said the New Zealand economy remained subdued despite the high commodity prices and signs of recovery in the housing market. The local economic picture is influenced by a slow rebuild of Christchurch damaged buildings and weak household spending.

“In the domestic economy we continue to see modest growth,” Bollard said.

Inflation under control

“Over recent months there have been signs of a limited recovery in household spending and the housing market. Further ahead, repairs and reconstruction in Canterbury will also provide a significant boost for an extended period, though there may be further delays resulting from the aftershocks,” he said. “Reassuringly, inflation pressures have remained well contained. Inflation has declined and now sits below 2 percent.”

The Consumer Price Index fell unexpectedly in the December quarter, dragging the annual inflation rate down to 1.8% and causing some economists to extend their forecasts for a flat OCR until late in 2012. The Reserve Bank Governor’s Policy Targets Agreement with the government specifies that the Reserve Bank must aim for inflation of 1-3% over the medium term.

See more here in our 'Crystal Ball' report on interest rate, house price and economic expectations, along with views on the fixed vs floating debate.

Hard to get NZ$ down - Key

Prime Minister John Key said on Thursday afternoon that the high New Zealand dollar was taking pressure off Bollard to raise interest rates, by taking pressure off imported costs like petrol prices.

“We can see that inflation now is relatively low, in fact we saw the last quarter was deflation effectively. From that perspective that’s taking pressure off Alan Bollard. The probability of him raising interest rates any time soon is very low because of that, so [the high New Zealand dollar is] helping him do his work," Key told media after giving a speech in Auckland.

Key acknowledged it was difficult for non-commodity exporters to compete with a high exchange rate.

It had been the government’s view for some time that it would like a lower currency. However it had also acknowledged that for an economy like New Zealand, with a free floating exchange rate, that imported a lot of capital, that was a “very difficult thing to achieve,” he said.

Economist reaction

Westpac's economists

The Reserve Bank has implicitly pushed out the expected timing of rate hikes, beyond the June start date that was projected in the December Monetary Policy Statement.  This was broadly the communication that the market was expecting from the central bank; the difference of opinion between the RBNZ and market pricing (which suggests hikes delayed until well into next year) will probably not be resolved until later in the year, as we get more resolution on reconstruction and Europe.

As expected, the Reserve Bank signalled a softening of its near-term policy stance without getting too specific in today's short statement.  The key change is the small but purposeful omission from the final sentence: while the December media release noted that it remained prudent "for now" to keep the OCR on hold, those two words were removed this time.  That eliminated the sense of pending hikes that was present in the December MPS.

The rest of the statement was a mix of pluses and minuses relative to the last review.  On the plus side, the RBNZ noted that financial market sentiment has improved slightly, particularly in Europe.  The global situation remains tenuous, so for a typically conservative central bank to acknowledge some improvement is actually a meaningful bit of information about the RBNZ's thinking.  Another positive was that the pickup in the housing market and household spending were acknowledged in the statement for the first time.

On the side of easier monetary policy, inflation was "reassuringly" remained well-contained - the softer CPI outturns recently will have come as less of a worry than as a relief compared to the large upside surprises in the first half of 2011.  The RBNZ also noted the recent gains in the NZ dollar, and the potential for further delays to rebuilding in Canterbury after the recent swarm of aftershocks.

ASB Economists

There were no surprises from the RBNZ at today’s announcement, as it stuck to the same punch line from December. The RBNZ appeared slightly more upbeat on the international front, noting the improved sentiment. However, the RBNZ was more wary on domestic developments noting the high NZD weighing export returns and the likelihood of further delays to Canterbury rebuilding. 

These are key factors that will be underpinning NZ’s economic recovery over the coming years, and in light of weakness in these areas it is likely the RBNZ is reassessing the timing of OCR increases (its December MPS forecasts were consistent with a mid-2012 start).  We continue to expect the RBNZ wait until at least December 2012 before lifting the OCR.  There is no urgency to lift interest rates on the domestic front, and the RBNZ needs to remain wary of the risks around the Eurozone debt crisis and global economic outlook.

BNZ's Head of Research Stephen Toplis

We judge the Reserve Bank has today essentially watered-down/delayed the OCR tightening schedule it outlined so well and wisely in December. The big swing factor remains the globe’s path. But providing this holds together, the NZ economy should keep recovering, to the point of requiring a less-stimulative OCR down the track.

Some might argue it has (finally) ditched its tightening bias altogether, in finishing its statement with “…it remains prudent to keep the OCR on hold at 2.50%” compared to the December MPS when it ended with “…it remains prudent for now to keep the OCR on hold at 2.50%” (emphasis added by BNZ).

However, we would not go that far. Recall the December MPS implied OCR hikes beginning around mid this year, with a peak of 3.75% later in 2013. Would the Bank’s implied cash rate track now have nothing at all; so a whole 125bps less than seven weeks ago? Not likely. More likely, the RBNZ has mainly delayed its tightening schedule, which is what it will make clear in the fullness of its March Monetary Policy Statement.

For our money, today’s Statement, while toned down, was still open-ended enough to leave us with our September hike call. However, the risks clearly keep shifting toward this being delayed further. For the meantime, we prefer to keep watching the economic information for direction.

ANZ's Economists

The RBNZ stuck with the same ending paragraph as the one used in the December MPS, but omitted the words “for now”.  This is as close to a neutral stance as one could have expected.

The RBNZ have made explicit mention of global growth risks, rising funding costs, the strong NZD, and potential delays of the rebuilding of Christchurch.  A high degree of comfort over the inflation outlook, combined with a weaker activity outlook, have provided them with considerable scope to stay on the sidelines.

We do not see a RBNZ hike until December at the earliest.

HSBC's Paul Bloxham

References by the RBNZ to rates being at ‘emergency settings’ are now clearly a thing of the past.

A cash rate at 2.50% seems likely to be with us for a while.

With inflation well contained, local growth only modest and persistent global risks, the RBNZ have deemed it prudent to retain their very low interest rates for the time being.

We expect that weaker global conditions in early 2012 will keep them on hold in H1. But that an improvement later in the year, particularly in Asia, plus the eventual arrival of the boost from the reconstruction of Canterbury, means the next move will be up (which we expect in Q3).

Here is the full RBNZ statement below:

The Reserve Bank today left the Official Cash Rate (OCR) unchanged at 2.5 percent.

Reserve Bank Governor Alan Bollard said: “Since the time of the December Statement, financial market sentiment has improved slightly, with increased liquidity in European financial markets. However, the global economy remains fragile and risks to the outlook remain.

“World prices for New Zealand’s export commodities have remained elevated but the recent appreciation of the New Zealand dollar is reducing exporters’ returns. The European debt crisis has also increased the cost of international funding, which will likely pressure funding costs for New Zealand banks over the coming year.

“In the domestic economy we continue to see modest growth. Over recent months there have been signs of a limited recovery in household spending and the housing market. Further ahead, repairs and reconstruction in Canterbury will also provide a significant boost for an extended period, though there may be further delays resulting from the aftershocks.

“Reassuringly, inflation pressures have remained well contained. Inflation has declined and now sits below 2 percent.

“Given ongoing uncertainty around global conditions and the moderate pace of domestic demand, it remains prudent to keep the OCR on hold at 2.5 percent.”

(Updates with ASB, Westpac, ANZ, BNZ, HSBC economist reaction, NZ$ firms towards 82 USc; Adds interactive chart)