RBNZ holds Official Cash Rate at 2.5% as expected; raises forecast rate track by 10-20 bps in 2015; sees house price inflation up as high as 14%

By Bernard Hickey

The Reserve Bank has left the Official Cash Rate on hold at 2.5% as expected and repeated its assurance it will leave it there until at least 2014.

It increased its forecast track for interest rates by 10-20 basis points through 2015 and early 2016, but such a forecast implies floating mortgage rates would only rise around 1% over the next two years, before rising a further 0.5% in late 2015 and early 2016, which implies a rise in floating mortgage rates to around 7% from 5.5% now. The Reserve Bank's forecast for the 90 day bill rate, which is seen as a proxy for the OCR, suggests it thinks it won't start increasing interest rates until the June or September quarters of 2014.

The central bank forecast consumer price inflation would remain within the bank's 1-3% target band over the next four years despite a surge in economic growth towards 3.5% by the second half of next year because of the Christchurch rebuild and Auckland's booming housing sector.

However, the bank also forecast national house price inflation could rise as high as 14% in early 2014, which would force interest rates around 1% higher than its current forecast track.

The bank again warned it did not want to see house price inflation endangering its financial or price stability targets, but it made no comment in its June quarter Monetary Policy Statement (MPS) about whether or when it would use its new macro-prudential policy tool kit, which include 'speed limits' on low deposit mortgages.

Reserve Bank Governor Graeme Wheeler said the global outlook remained mixed with disappointing data in Europe and some other countries, while there was more positive news from the United States and Japan.

“Growth in the New Zealand economy is picking up but remains uneven across sectors," Wheeler said.

"Consumption is increasing and reconstruction in Canterbury continues to gather pace and will be reinforced by a broader national recovery in construction activity, particularly in Auckland. This will support aggregate activity and eventually help to ease the housing shortage," he said.

“In the meantime rapid house price inflation persists in Auckland and Canterbury.  As previously noted, the Reserve Bank does not want to see financial or price stability compromised by housing demand getting too far ahead of the supply response."

Wheeler said the New Zealand dollar remained over-valued despite its sharp fall of recent weeks. I continued to be a "headwind for the tradables sector, restricting export earnings and encouraging demand for imports."

The bank said it expected GDP growth to accelerate towards about 3.5% by the second half of 2014, and inflation to rise towards the midpoint of the 1 to 3 percent target band.

Economist reaction

BNZ Senior Economist Stephen Toplis said the currency's fall over the last month was likely to create inflationary pressures if it was maintained for long, particularly given robust growth in the rest of the economy.

"Whatever the truth in the RBNZ’s thinking it will have to change its view if the currency stays lower for longer," Toplis said in this research note.

"We actually believe the NZD will bounce off its current lows but it’s got a very long way to go to get to the TWI of 77.4 that the RBNZ assumes will hold for the next twelve months. It currently sits at 74. We are quick to point out that the RBNZ’s assumptions are not much different to our own which, similarly, now look somewhat heroic. In the same vein as the Bank, we will thus leave our rate track unchanged," he said. BNZ forecasts the first rate hike in the March quarter of next year.

"It’s just that our rate projections already have a first rate hike in Q1 2014 and warn, further, that we will be bringing this forward in the event that the NZD does not bounce aggressively soon. It should not be considered inconceivable that you get as much as 50 points of hikes before year’s end."

ANZ economists Sharon Zollner and Mark Smith said the Reserve Bank's statement was in line with expectations and they still expected the Reserve Bank to start lncreasing interest rates in early 2014.

They said the risks were now greater of higher inflation rather than lower inflation than the Reserve Bank's expectations because of the housing market's strength and the Canterbury rebuild.

"Downside inflation risks are starting to look a bit outnumbered. 

"With relatively high “core” inflation, the profile looks vulnerable on the upside should the NZD drop sharply," they said.

ASB Senior Economist Jane Turner said there were few fresh policy implications from the June MPS.

"The main forecast change was a higher TWI track, at 77.5, reflecting where the TWI had been tracking around the time the forecasts were finalised," Turner said. The TWI is currently 73.9.

"That higher TWI track has effectively offset the inflationary impact of upwardly-revised house price inflation and flow-on effects to consumer spending.  The RBNZ is more confident that economic growth is accelerating, and underlying the forecasts is slightly stronger household demand," she said.

"We still see the risks as roughly balanced, with much depending on the housing market.  It is possible that housing strength brings about an earlier start, particularly if any macro-prudential action is ineffective.  But, housing may remain within the RBNZ's tolerances and anticipate some recovery in the broader NZD over time."

TD Securities' economist Annette Beacher said she was sticking to her forecast of a December 12 OCR hike. 

"Overall, the statement is relatively upbeat, and it’s only the heroic TWI forecasts (H2 upgraded from 75.5 to 77.4) that keep inflation so low over the forecast horizon.  Hence if the TWI remains at current levels of 74, inflation clearly has upside," she said.

"We leave our December +25bp in place, with our eyes firmly on house price demand outstripping lagging supply, and household credit/debt is marching upwards after years of consolidation."

Westpac Chief Economist Dominick Stephens said the MPS had not changed his view that the hiking cycle would be significant and start from March 2014.

"We are more hawkish than the RBNZ because we believe rising house prices and the Canterbury construction boom will translate into inflation more fully than the RBNZ expects," Stephens said.

"We were encouraged to see the RBNZ modify its dubious assumption that rising house prices will not provoke much extra consumer spending - but the RBNZ still has not gone far enough, in our opinion," he said.

(Updated with detail/quotes/reaction)