By Bernard Hickey
After nearly three years of stable, record-low interest rates and warnings of future hikes, the Reserve Bank has finally done it.
The central bank announced a 0.25% increase in the Official Cash Rate (OCR) to 2.75% in releasing its March Quarter Monetary Policy Statement. It also forecast short-term interest rates would rise around 2.5% by early 2017 as it noted building inflation pressures.
The bank also slightly raised and front-loaded its forecast for interest rate hikes this year, assuming around 1.25% of hikes before the end of 2014 and a further 1% of hikes in 2015. Governor Graeme Wheeler said the 125 basis points this year was slightly above the market expectations for 110 basis points of increases.
The increase was in line with expectations, but the higher interest rate track forecast signals a more hawkish view by the bank. The New Zealand dollar rose almost a cent to 85.6 USc, which lifted the Trade Weighted Index to a fresh record high of close to 80.
Meanwhile, the bank also noted the recent surge in migration as a factor boosting the economy and inflationary pressures, particularly in the housing sector.
However, it also reported its speed limit on high Loan to Value Ratio (LVR) loans was moderating house price inflation and the impact had been more front-loaded than it expected.
Wheeler later told the news conference the bank's modelling estimated house price inflation would have been 11% now without the high LVR limit, implying it reduced house price inflation by about 2.5% to the current 8.4% rate of house price inflation.
The bank also pointed to the high New Zealand dollar as a factor driving tradeable sector prices lower, although it said its strength was not sustainable in the long run.
Market and economist reaction
The New Zealand dollar jumped around half a cent to over 85.2 USc immediately after the decision and the Reserve Bank's comments, including those from the Governor in the news conference indicating the Reserve Bank would not intervene in the currency market, despite it being unsustainably high over the long term. The currency rose further in mid-afternoon trade.
ASB Chief Economist Nick Tuffley lifted his OCR peak forecast to 4.5% from 4% after the decision and statement.
"Given the RBNZ has front-loaded its interest rate increases a little more into 2014, we now expect 4 OCR increases of 25bp each over 2014," Tuffley said, adding he saw the next three hikes in April, July and December.
"To us, factors such as the risk of further NZD appreciation and a lot of uncertainty over how households will react to OCR increases are reasons for expecting the RBNZ will not lift the OCR 3 or 4 times in immediate succession," Tuffley said.
Westpac Economists Dominick Stephens and Michael Gordon also pointed to the Reserve Bank's implied 'front-loading' of forecast rate hikes.
"That doesn’t leave much wiggle room to debate the timing of those hikes, and supports our prior view that the OCR will be increased further at the next three reviews in April, June and July, with further hikes from December onward," Stephens and Gordon said.
Parsing the statements
Here is a comparison of today's statement on monetary policy with the Reserve Bank's last statement on January 30.
March 13 - The Reserve Bank today increased the OCR by 25 basis points to 2.75 percent. New Zealand’s economic expansion has considerable momentum, and growth is becoming more broad-based. GDP is estimated to have grown by 3.3 percent in the year to March. Growth is gradually increasing in New Zealand’s trading partners. However, improvements in major economies have required exceptional support from monetary policy. Global financial conditions continue to be very accommodating, with bond yields in most advanced countries low and equity markets performing strongly.
January 30 - 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 difference: This time the bank noted the economic expansion now had considerable momentum and was more broad-based, whereas last time it was only "moderate but mixed".
March 13 - Prices for New Zealand’s export commodities remain very high, and especially for dairy. Domestically, the extended period of low interest rates and continued strong growth in construction sector activity have supported recovery. A rapid increase in net immigration over the past 18 months has also boosted housing and consumer demand. Confidence is very high among consumers and businesses, and hiring and investment intentions continue to increase.
Jan 30 - 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.
The difference: The Reserve Bank's focus on a surge in net migration is a new focus in the latest statement.
March 13 - Growth in demand has been absorbing spare capacity, and inflationary pressures are becoming apparent, especially in the non-tradables sector. In the tradables sector, weak import price inflation and the high exchange rate have held down inflation. The high exchange rate remains a headwind to the tradables sector. The Bank does not believe the current level of the exchange rate is sustainable in the long run.
January 30 – 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.
The difference: The bank focused more this time around on non-tradeable inflation, noting later in the full Monetary Policy Statement that tradeable prices would actually fall because of the high New Zealand. It left its language about the New Zealand dollar's current level being unsustainable.
March 13 - There has been some moderation in the housing market. Restrictions on high loan-to-value ratio mortgage lending are starting to ease pressure, and rising interest rates will have a further moderating influence. However, the increase in net immigration flows will remain an offsetting influence. While headline inflation has been moderate, inflationary pressures are increasing and are expected to continue doing so over the next two years.
In this environment it is important that inflation expectations remain contained. To achieve this it is necessary to raise interest rates towards a level at which they are no longer adding to demand. The Bank is commencing this adjustment today. The speed and extent to which the OCR will be raised will depend on economic data and our continuing assessment of emerging inflationary pressures. By increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point, the Bank is seeking to ensure that the economic expansion can be sustained.
January 30 - 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 difference: This time around the bank was less specific on the types of inflationary pressures that would determine the speed of the rate
(Updated with Parsing of the statements and comments from news conference, market reaction, economist comments)