By Bernard Hickey
The Reserve Bank has held off hiking the Official Cash Rate for the first time in four years, but has warned it expects to start increasing interest rates to "more normal" levels "soon."
This is the 23rd consecutive decision to hold the OCR at a record low 2.5%. Three out of 15 economists surveyed had expected the Reserve Bank to start tightening monetary policy with a 0.25% hike today, but the rest were forecasting the beginning of the next rate cycle on March 13 when the Reserve Bank releases its next full Monetary Policy Statement.
The New Zealand dollar dropped almost a cent in the first 20 minutes after the announcement to around 81.8 USc, but bounced a little to 82.1 USc by late morning. The wholesale two year 'swaps' interest rate, which is a base for two year mortgage rates, fell five basis points.
Governor Graeme Wheeler said headline inflation had been moderate, but was expected to increase over the next two years.
"In this environment, there is a need to return interest rates to more-normal levels. The Bank expects to start this adjustment soon," Wheeler said.
"The Bank remains committed to increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point," he said.
"The scale and speed of the rise in the OCR will depend on future economic indicators."
Wheeler said in his full December Quarter Monetary Policy Statement (MPS) news conference that he expected the bank would increase the OCR by 2.25% by early 2016. Advertised fixed mortgage rates have risen around 50 basis points on average since early December as financial markets expect the OCR to be increased by 1.25 percentage points in calendar 2014.
The Reserve Bank has never said at what level 'normal' interest rates might be, although Deputy Governor John McDermott said in a speech in October last year that the 'neutral' was around 4.5% for the 90 day bill rate, which is where the bank forecast the OCR would rise to by early 2016.
ASB Chief Economist Nick Tuffley said a March hike of 25 basis points was now a "near certainty, certainty – barring an external shock or a marked and sudden deterioration in New Zealand’s prospects." He expected 25 basis point increases in March, June and December of this year, followed by similar sized hikes in March, September and December of next year to lift the OCR to 4%, which was a more gradual tightening cycle than the consensus.
Tuffley cited a higher New Zealand dollar track than the Reserve Bank expected. "We also anticipate a higher degree of debt and interest rate sensitivity than in past tightening cycles," he said.
Westpac Chief Economist Dominick Stephens said the statement "gave the impression that the RBNZ is now considering a more aggressive hiking cycle than it signalled six weeks ago in the December MPS."
"Extremely bullish words were chosen to describe the current state of and outlook for economic activity in New Zealand. The RBNZ sounded significantly more concerned about inflation pressures, particularly with the comment: 'Construction costs are increasing and risk feeding through to broader costs in the economy'," Stephens said. He is forecasting five 25 basis point hikes in 2014 and a peak of 5.5% in 2016.
"All up, the RBNZ seems to be a central bank calmly preparing for a well-signalled and steady series of OCR hikes. Yes, the total size of the hiking cycle will be slightly larger than previously signalled. But there were no signs of panic in this press release."
HSBC Australia and NZ Chief Economist Paul Bloxham, who had predicted a rate hike today, said the Reserve Bank had been "spooked" by the high New Zealand dollar.
"The central bank was noticeably more upbeat on the outlook for domestic activity. However, their concern over the high NZD seems to have held them back from hiking rates today. Instead, the RBNZ significantly bolstered their tightening bias, flagging that interest rate rises would be needed and noting that they expect 'to start this adjustment soon’," Bloxham said, adding a hike was likely in March.
ANZ Chief Economist Cameron Bagrie, who had called for a rate hike today, said he now expected the Reserve Bank to increase the OCR by 75 basis points over the first half of 2014. There are three decisions due by June 12. He then expected a 'Lange-style cup of tea' before a resumption of the tightening cycle towards a more normal level of 4.5% by 2016.
"We expect the economy to show a response to 3 hikes but this is tomorrow’s story and we expect data to print very strongly over the coming months which will keep the market biased towards policy stimulus being withdrawn in a steady fashion for now," he said.
BNZ Economist Craig Ebert said the bank had beefed up its hawkish rhetoric.
"If the “scale and speed of the rise in the OCR will depend on future economic indicators” we suggest it won’t be long before the RBNZ gets a hurry up from the data," he said.
TD Securities Economist Annette Beacher said she had expected the Reserve Bank to explain its reasons for an imminent hike, but not actually pull the trigger today. She suggested the bank may not have wanted to have put itself into the camp with emerging market central banks such as Turkey and South Africa, that have had to sharply increase their interest rates this week to defend their currencies.
"These issues are not the concern of the RBNZ, but strong growth and rising inflation are," Beacher said, adding the statement was as hawkish as expected.
Labour Leader David Cunliffe National's response to skyrocketing house prices and rising rents had been inept and higher interest rates would heap more pain on homeowners, renters and first home buyers.
“National has repeatedly claimed credit for low interest rates. They now have to take responsibility for looming rate hikes," Cunliffe said.
“Interest rate rises will also push up the already high exchange rate, creating obstacles for our exporters, dampening business expansion and slowing job creation," he said, adding it would widen inequality.
Green Co-Leader Russel Norman said the imminent rate hike demonstrated the Government's failure to rebalance the economy.
“Once again, New Zealand’s economic recovery is betraying the same underlying structural weaknesses of the last recovery; National has materially failed to rebalance our economy away from borrowing and consumption towards savings, investment, and exports," Norman said.
“New Zealand is enjoying the highest terms-of-trade since 1973 yet we’re still running the third highest current account deficit in the developed world. If this is as good as it gets, we haven’t made the kinds of changes needed to secure our long-term prosperity," he said.
"National’s failure to address the Auckland housing shortage with a mixture of demand and supply-side measures are forcing the Reserve Bank to hike rates, hurting the real economy."
Parsing the statement
The Reserve Bank's statement with its decision was the usual four to five paragraphs issued between full quarterly MPSes, although the MPSes also include a policy assessment that is comparable with the four to five paragraph summary.
Here's my paragraph-by-paragraph comparison of today's statement with the December assessment (in quoted form) to see how the bank's view and comments have changed.
January 30 statement
"The Reserve Bank today left the Official Cash Rate unchanged at 2.5 percent.
"New Zealand’s economic expansion has considerable momentum. Prices for New Zealand’s export commodities remain very high, especially for dairy products. Consumer and business confidence are strong and the rapid rise in net inward migration over the past year has added to consumption and housing demand. Construction activity is being lifted by the Canterbury rebuild and by work in Auckland to address the housing shortage. Continued fiscal consolidation will partly offset the strength in demand. GDP grew by 3.5 percent in the year to September, and growth is expected to continue around this rate over the coming year."
The Reserve Bank today left the Official Cash Rate unchanged at 2.5 percent. Growth remains moderate but mixed for New Zealand’s main trading partners. Nevertheless, export prices for New Zealand’s main commodities, and especially dairy produce, have continued to increase. New Zealand’s GDP is estimated to have grown at over 3 percent in the year to the September quarter and the expansion in the economy has considerable momentum. New Zealand’s terms of trade are at a 40-year high, household spending is rising and construction activity is being lifted by the Canterbury rebuild and the response to the housing shortage in Auckland. Continued fiscal consolidation and the high exchange rate will partly offset the strength in domestic demand. The high exchange rate is a particular headwind for the tradables sector and the Bank does not believe it is sustainable in the long run.
The differences here are around the speed of the economic growth, which the bank still says has "considerable momentum." The bank is pointing out GDP grew 3.5% in the year to September and is expected to continue growing at a similar rate over 2014, which was more than the bank's December estimate of 3%. It has pointed to the rapid rise in net inward migration boosting consumption and housing demand, although it talked about that elsewhere in last month's statement.
"While agricultural export prices are expected to come off their peak levels, overall export demand should benefit from improving growth in the global economy. However, improvements in the major economies have required exceptional monetary accommodation and there remains uncertainty about the timing of withdrawal of this stimulus and its effects, especially on emerging market economies."
This is a newish section in the statement, emphasizing some of the emerging markets and financial drama of the last couple of weeks. Back in December markets were much calmer. It also forecasts again the Reserve Bank expects export prices to recede from their peaks, as it did last time, although they haven't receded much since then.
Annual CPI inflation was 1.6 percent in 2013, and forward-looking measures of firms’ pricing intentions have been rising. Construction costs are increasing and risk feeding through to broader costs in the economy. At the same time, there appears to have been some moderation in the housing market in recent months. The high exchange rate continues to dampen inflation in the traded goods sector, but the Bank does not believe the current level of the exchange rate is sustainable in the long run.
House price inflation is high in Auckland and other regions due to the housing shortage, and demand pressures associated with low interest rates and rising net inward migration. Restrictions on high loan-to-value mortgage lending, introduced in October, should help slow house price inflation. Data to date are limited on the effects of these restrictions. We will continue to monitor outcomes in the housing market closely. Annual CPI inflation increased to 1.4 percent in the September quarter and inflation pressures are projected to increase. The extent and timing of such pressures will depend largely on movements in the exchange rate, changes in commodity prices, and the degree to which momentum in the housing market and construction activity spills over into broader cost and price pressures.
This is the section where the Reserve Bank talks about house prices and inflation. Back in December the bank specifically mentioned high house price inflation in Auckland. This time around the bank hasn't singled out Auckland, but has noted a moderation in the housing market in recent months. The bank repeated that it did not think the high exchange rate was sustainable in the long run.
"While headline inflation has been moderate, inflationary pressures are expected to increase over the next two years. In this environment, there is a need to return interest rates to more-normal levels. The Bank expects to start this adjustment soon. The Bank remains committed to increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point. The scale and speed of the rise in the OCR will depend on future economic indicators."
The Bank will increase the OCR as needed in order to keep future average inflation near the 2 percent target midpoint”
This is the business end of the statement. It indicates the bank's thinking on interest rates. In this statement the bank has emphasized the need to start increasing interest rates to more normal levels "soon."
The talk of 'more-normal' levels isn't that unusual. The bank has talked about it in the past but the use of the 'normal' phrase in the state has placed a greater emphasis on it. The bank has cleverly given itself some wiggle room with the use of the word 'soon' and the comment about the scale and speed being dependent on economic indicators.
Most economists think 'soon' means March 13. We'll find out a lot more about the Reserve Bank's thinking and a fresh set of forecasts then.
(Updated with currency move, economist reaction, political reaction)