BNZ's Stephen Toplis says case growing for OCR cut; 'Not BNZ's central forecast, but is it plausible? Hell yes'

BNZ's Stephen Toplis says case growing for OCR cut; 'Not BNZ's central forecast, but is it plausible? Hell yes'
Stephen Toplis, BNZ head of research

By Alex Tarrant

The case for an Official Cash Rate cut is growing, BNZ head of research Stephen Toplis says.

"For some time now, financial markets have been pricing in a relatively high probability that the Reserve Bank of New Zealand would lower its cash rate. We have been staunchly opposed to that view largely because we felt markets were failing to differentiate between what was going on in New Zealand compared to what was happening around the rest of the world," Toplis said.

"Now, however, domestic indicators have turned sour and we believe the time is ripe to contemplate the very real possibility the RBNZ could pull the trigger. Is it our central forecast? No. Is it plausible? Hell yes."

There was no doubt the economy was currently going through a soggy patch.

"There is no question that the majority of data are surprising on the downside. There is equally little doubt that (a) the central bank will be forced to lower its inflation forecasts and (b) will likely need to present a less aggressive interest rate track. It may even go so far as to speculate on what it would take for it to lower the cash rate," Toplis said.

"That said, we are hanging, by our fingernails, to the view that the economy is far from dead and does not warrant extra monetary support. Housing is robust, business confidence portends trend growth, credit aggregates are edging higher, global demand is stabilizing, commodity prices are rising, and consumer confidence is holding up," he said.

"Indeed, it is conceivable that in the current environment any further monetary policy support might ultimately prove counterproductive."

"But we concede that we are nervous and folk are right to ponder whether a cut might be appropriate. We have no doubt this very question will also be asked within the walls of the Bank.

"And, if the data continue to deteriorate, it is entirely plausible that the Bank will feel the need to swing into action. For the first time this year we accept that it is now appropriate for the market to price in some chance of a rate cut at the next meeting even if the 30% presently priced seems a tad overdone," Toplis said.

"Similarly, while our core view is that the currently priced 100% prospect of a future rate cut may be inappropriate it is entirely conceivable that the market might move toward pricing more than one cut in the event that the RBNZ shows any sign of allowing interest rates to fall when it produces its 6 December statement," he said.

Read Toplis' full comments below:

For some time now, financial markets have been pricing in a relatively high probability that the Reserve Bank of New Zealand would lower its cash rate. We have been staunchly opposed to that view largely because we felt markets were failing to differentiate between what was going on in New Zealand compared to what was happening around the rest of the world. Now, however, domestic indicators have turned sour and we believe the time is ripe to contemplate the very real possibility the RBNZ could pull the trigger. Is it our central forecast? No. Is it plausible? Hell yes.

It’s worth reminding all that the RBNZ has the exclusive mandate of targeting annual CPI inflation within a 1.0% to 3.0% target band. That commitment has recently been upgraded in the newly-signed Policy Targets Agreement to a focus on the mid-point of that band. What the Reserve Bank thinks about future inflation is thus the be all and end all of monetary policy. So, with the RBNZ’s September MPS revealing forecast inflation to soon rise to the middle of that band, predicated on the cash rate rising slowly from late next year/early 2014, there has been, prima facie, little reason to talk about easing unless, of course, the Bank has been provided good reason to change that forecast. Herein lies the crux of the matter. It probably has.

To start with, the Q3 CPI outturn turned out lower than the Bank had anticipated at 0.3% rather than the 0.5% forecast. The quarterly outturn, in itself, is of no great consequence. What is, though, has been a general tendency for the RBNZ to be surprised on the downside over the last year or so. Indeed the Bank has underestimated every one of the last five inflation outcomes. This will have the folk down at the Bank pondering why this might be so and posing the question that if a systematic bias has developed that inflation might in fact end up languishing below the mid-point of its band for some time to come. Moreover, with petrol prices plummeting through Q4 it already looks as if Q4 CPI inflation will again print well below the Bank’s 0.5% pick. We are forecasting 0.2% in a quarter (with downside risk) which has a track record of surprising all and sundry to the downside. After all, three of the last four December quarters have printed negative. We’ll have to wait until mid January to find out the truth of the matter but the potential for surprise is clear.

The impact of these changes should not be underestimated. If, for example, the Bank decides it has got a bias its forecasts of 0.1% per quarter then adjusting for this and recent petrol price movements alone could see their annual inflation forecast drop to 1.3% one year hence. That would be two years of sub-2% inflation.

There are two aspects to the low CPI numbers. Not only do they bring into question the future forecasts but also the low published numbers will tend to force inflation expectations downwards which, in turn, will help subdue future inflation. Annual CPI inflation is currently at a meagre 0.8% and, if our own forecasts are correct, will stay sub 2.0% until at least Q4 of next year.

Perhaps the most important aspect of inflation surprising on the downside is that, all other things being equal, it suggests the amount of spare capacity in the economy (the output gap) is greater than the Bank had assumed. This is important as it implies that the economy can grow stronger for longer without creating inflationary pressure.

And whatever the case on this front, spare capacity is clearly greater than expected to the extent that the unemployment rate recently printed miles above RBNZ expectations – 7.3% versus 6.7%. So, again, the starting point suggests much more room to grow without generating inflation. Moreover, the widening gap between employment and GDP growth intimates a surge in productivity that could only be disinflationary.

As if all this stuff wasn’t enough, the exchange rate refuses to roll over and die. Despite a string of relatively weak data the TWI still sits at 72.8 against an RBNZ expectation that it would average 72.0 through the December quarter and 71.7 in Q1 2013. The expectation and outturn are very close but ongoing strength in the NZD could yet sneak another point or two off annual inflation forecasts.

Putting all this together, one can only conclude that the RBNZ’s inflation forecasts must be lowered relative to those published in its September Monetary Policy Statement. This, from a consistency perspective, must then leave the Bank with four options:

-        Further delay its printed tightening cycle;

-        Remove the tightening altogether;

-        Move to an easing bias; or

-        Cut rates.

The argument for a cut is, we accept, very strong but we just don’t believe that it would be the right thing to do just yet.

Perhaps most important, in this regard, is the fact that a drop in interest rates is unlikely to provide the medicine that is required for the ailing economy: it won’t bolster Australian demand; it probably would have little impact on the exchange rate; and it is unlikely to boost consumer or business spending because the level of interest rates is providing no hurdle in these areas.

In contrast, a drop in interest rates might just pour further fuel on a housing market which is showing the first signs of speculative fervour - the last thing anyone wants or needs, at this stage in the economic cycle.

Some folk have concluded that the new Governor Graeme Wheeler is new to the job so would be reluctant to move rates and that he is more hawkish than his predecessor so would need a higher hurdle to respond. There may be an element of truth in these comments but we would strongly downplay their importance.

Wheeler appears to be a very “orthodox” macro-economist. He’s had enough time to get his head around all the local issues and will just be looking to the RBNZ’s current forecasting round to fine tune these views. He wouldn’t be in the slightest bit reluctant to move rates at this stage if the data and forecasts suggested this to be an appropriate response. Moreover, hawkishness is a relative concept. He might be more hawkish than Alan Bollard was but this doesn’t mean he would fail to jump when conditions demanded it.

There is no doubt the economy is going through a soggy patch. There is no question that the majority of data are surprising on the downside. There is equally little doubt that (a) the central bank will be forced to lower its inflation forecasts and (b) will likely need to present a less aggressive interest rate track. It may even go so far as to speculate on what it would take for it to lower the cash rate.

That said, we are hanging, by our fingernails, to the view that the economy is far from dead and does not warrant extra monetary support. Housing is robust, business confidence portends trend growth, credit aggregates are edging higher, global demand is stabilizing, commodity prices are rising, and consumer confidence is holding up. Indeed, it is conceivable that in the current environment any further monetary policy support might ultimately prove counterproductive.

But we concede that we are nervous and folk are right to ponder whether a cut might be appropriate. We have no doubt this very question will also be asked within the walls of the Bank. And, if the data continue to deteriorate, it is entirely plausible that the Bank will feel the need to swing into action. For the first time this year we accept that it is now appropriate for the market to price in some chance of a rate cut at the next meeting even if the 30% presently priced seems a tad overdone. Similarly, while our core view is that the currently priced 100% prospect of a future rate cut may be inappropriate it is entirely conceivable that the market might move toward pricing more than one cut in the event that the RBNZ shows any sign of allowing interest rates to fall when it produces its 6 December statement.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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21 Comments

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Which economic growth miracles will unfold if the RBNZ goes down the well trodden path to ZIRP?
 
England and the US, the ZIRP flagship nations, continue to suffer the indignities of below par growth and their long suffering tax-payers are further enveloped with government deficit finance solutions.

Who said its aiming for an "economic growth miracle"? how about not going into a recession or even a depression?
I'd settle for that..which is the idea....
Also dropping back our exchange rate a bit....also good.
I wouldnt say they were flagship nations for zero interest rates but  for austerity's failure...yes.
regards

Cuts, cuts,cuts
more. Cuts. Coming.
don't fix more than 6 months

Cuts were overdue b4 the quakes. Europe is sliding into wartime anarchy. Survival is thh
e game

Cuts were overdue b4 the quakes. Europe is sliding into wartime anarchy. Survival is thh
e game

What is rbnz target unemployment rate? 12%?

What ever it takes to curb that nasty inflation beastie.  Of course its currently on its knees and about to face plant.
regards
 

Rbnz doesn't want to cut. But will be forced to.

Greece. Spain. Portugal. USA fiscal cliff. Syria Iran Islamic terrorism. China timebomb.
Let's pretend we're in a protection zone.

MB could you please explain what would happen if the US goes over the "Fiscal Cliff." 

Unemployment increases, tax rates increase, interest rates? flatter for longer/or problem with refinancing leading to increased interest rates. All builds a case for a global reset.... who knows   -   big debtors sometimes call the shots,  e.g. if you owe the BNZ 500million it's probably their problem not yours.   
The point is -  in these perilous times why is NZ pretending nothing is wrong?, "lets keep a tight monetary policy" (relatively to global conditions).

Yup, just what I thought, nothing changes!
New Zealand is not pretending anything; at least, I don't think so.
HGW

 
 

Yet the experience of Japan suggests there is one clear negative outcome from ultra loose monetary policy: it does structural damage to the economy.

The problem starts with an excessively low cost of capital. Average interest rates on new corporate loans, both short and long term, are down to an unprecedented level in Japan of almost 1 per cent, while the average interest rate paid on overall corporate lending is just under 1.5 per cent. At these levels too many inefficient businesses are being kept alive, says Jesper Koll, head of equity research at JPMorgan in Tokyo.

 
http://www.ft.com/intl/cms/s/0/012b2f68-282b-11e2-a335-00144feabdc0.html...

Noone is saying it's ideal or a good thing. NZ will need to prop up as many businesses as possible over the next 3 years if we want people in paid employment.
The global environment will soon start sucking down a vortex - we've seen nothing yet. Aus & NZ have had 4 years of relative protection/buffer from a very very bad situation.  That buffer is dissipating.
Who cares what conventional economics says.  It's nearly time for emergency options.  No doubt we will react 12 months later than needed.
What possible harm could a 2.0 OCR do -  that's not already harming us? 
 

Love it SoreLoser,

Noun

1.

prop - a support placed beneath or against something to keep it from shaking or falling

pitprop, sprag - a wooden prop used to support the roof of a mine

Oh no, sorry  -  Mr DunnoKeyo is under instructions from IMF & EU & USA to pursue conventional economic policy while the rest of the gang party on with QE & ZIRP....
No support for business. No support for Exporters. No action on the high dollar. Cuts in education.  Cuts to Govt spending. (Relatively) HIGH interest rates.   Yep, that'll work to bring Nz to it's knees for parity to all the other cot-cases in the western economies.... 

Mortgage belt - let me make a big assumption, as you just have above, you've acheived far less superficially in your life than Dunnokeyo, but seems to think you're superior in being able to belittle him (such that he would care what you think) ? Not to worry, you're not the only one on here in that regard I also suspect
 

Grant A (A for Apologist for the banking fraternity) - good to see you are now an apologist for PM Key & National.   Well, I have been a National voter in the past (not the last election). Just cannot see how current policies can help -  there's a studied ignoring of realities. E.g. Oh, unemployment - household survey - has risen to 7.3,  should that really have been a surprise to a Prime Minister.
Sure, still have to admire the career sucess of JK,  perhaps he is in the Muldoon / Nixon / Clark semi-arrogance phase now.  Dangerous for a country to be in this phase of a political cycle at the same time as a precarious financial global situation.
Oh well  - status quo may work. IE at least minimal intervention can't risk damage by project.  Plus a little open gateway for high roller gamblers from China.
Telling the truth first time is always the best policy for a Prime Minister. 

You would be surprised at the amount of social media Data mining analysis that is going on.  I would imagine that the IT section of National & Labour etc would be continually scanning Interest.co, Kiwiblog, Whale Oil etc and doing content analysis based on names & trending topics  -   like a Twitterverse analysis.   Gives them a mood of the nation in the Blogosphere. So actually we are giving them free data!   & I'm sure they don't take offense.
I can claim higher qualifications than the PM, which only proves that there is a law of diminishing returns (financially) on too many postgrad quals!

That law applies to more than just degrees, and it's corollary speaks volumes on it's relationship to common sense: The more educated one is, the less one has!
HGW

An apologist for bankers and politicans ? No, its just that when I see crap talked, some of you ocassionally need to be called out on it - bankers and politicans just seem to be the subject where most crap is talked, and MB, you're a prize one for it. But I think you're last comment shows me why.

There will be a series of interest rate cuts in Australia over the next 18 months. NSW & Queensland economies are struggling & will need propping up.
New Zealand will not be raising interest rates for at least 2 years. We are currently on the verge of slipping into recession. An increasing chance of interest rate cuts in NZ as well.
Too bad about the housing market.... outside of select pockets in Auckland it's pretty much flatlining eveywhere else anyway.