By Bernard Hickey
The Reserve Bank has hiked the Official Cash Rate for a fourth time in five months as widely expected, but it has also signalled a pause in its rate hikes to assess how the tightening was affecting the economy.
"Encouragingly, the economy appears to be adjusting to the monetary policy tightening that has taken place since the start of the year," Reserve Bank Governor Graeme Wheeler said.
"It is prudent that there now be a period of assessment before interest rates adjust further towards a more-neutral level," he said.
Economists had forecast the 0.25% rise to 3.5%, and had said the Reserve Bank could now pause the rate hiking cycle until December at the earliest, and possibly into early next year. The Reserve Bank has previously forecast another 1.25% of hikes through late 2014 and the 2015 year as it drags the OCR up to around its view of a 'neutral' level of 4.5%. This would imply floating mortgage rates well over 7% and headed for 8%.
Economists said after the announcement the pause could last until March and that the Reserve Bank has opened the door towards currency intervention if the New Zealand stayed high.
ANZ Chief Economist Cameron Bagrie said the Reserve Bank's statement was about as dovish it could be without moving completely into netural.
"Clearly the RBNZ is more comfortable with where the economy is headed on the inflation front, the risk profile is more nuanced (a bit more downside has been opened up), and the currency is still problematic. So in the words of David Lange, we’re stopping for a cup of tea," Bagrie said, adding he now expected the OCR to remain on hold until March 12.
The Reserve Bank's seven-paragraph statement was broadly as expected, although it talked particularly tough on the high New Zealand dollar.
"Over recent months, export prices for dairy and timber have fallen, and these will reduce primary sector incomes over the coming year," Wheeler said.
"With the exchange rate yet to adjust to weakening commodity prices, the level of the New Zealand dollar is unjustified and unsustainable and there is potential for a significant fall," he said.
The New Zealand dollar fell sharply immediately after the statement. It fell almost a cent to 86.1 USc by 9.20 am. Economists said the option of intervention to push the currency down was now open to the Reserve Bank.
The bank said the economy was expected to grow at an annual pace of 3.7% in calendar 2014, with global financial conditions very accommodating.
Growth among New Zealand's main trading partners had eased slightly, but for temporary reasons, it said. Construction in Canterbury was growing strongly, while migration was adding to housing and household demand, although the bank noted house price inflation had moderated.
"Inflation remains moderate, but strong growth in output has been absorbing spare capacity. This is expected to add to non-tradables inflation," Wheeler said.
"Wage inflation is subdued, reflecting recent low inflation outcomes, increased labour force participation, and strong net immigration," he said.
"It is important that inflation expectations remain contained. Today’s move will help keep future average inflation near the 2 percent target mid-point and ensure that the economic expansion can be sustained."
The Governor repeated his previous comments that the speed and extent of further tightening depended on the "assessment of the impact of the tightening in monetary policy to date, and the implications of future economic and financial data for inflationary pressures."
BNZ Head of Research Stephen Toplis said he had left his forecast of a resumption in hikes on December 11, a cash rate of 4.75% by the end of 2015 and a peak of 5%.
"It should have come as no surprise that the RBNZ pushed ahead with today’s adjustment, despite the rising clamor from lobby groups for it not to do so. In this regard, it was notable that the RBNZ highlighted that it was forecasting growth of 3.7% this year – well above its 2.8% speed limit," Toplis said.
He said the Reserve Bank could not have been more aggressive with its comments on the currency if it had tried.
"The RBNZ must have been overjoyed by the market’s response to these comments and the OCR review more generally: the NZD has fallen three quarters of a cent; a 50/50 chance of a rate hike is priced in for December and, while there has been a modest decline in swap yields, a firm upward slope in the rates curve remains with the ten year swap sitting at 4.71%," he said.
ANZ Chief Economist Cameron Bagrie said he now expected the Reserve Bank to wait until March before next increasing the OCR.
"The currency rhetoric has been stepped up; with the NZD is now noted to be “unjustified and unsustainable and there is potential for a significant fall”. On the face of it, “unjustified” opens the door to currency intervention," Bagrie said.
"We’re not convinced the trigger will be pulled (more likely we’ll see covert and passive action as opposed to open intervention) but we’re on notice," he said.
We expect the Bank to remain on hold until next March, and stick to our long-held view of a moderate path of policy tightening by historical standards this cycle," he said, adding that fixed mortgage rates could fall in coming weeks.
Westpac Chief Economist Dominick Stephens said he expected the current pause would last until January 29 and the Reserve was now looking at an OCR of 4.5% by June 2016, rather than the 4.75% signalled in its June forecast.
He said he interpreted the Reserve Bank's currency warning "as a direct warning that the RBNZ may intervene in foreign exchange markets by selling New Zealand dollars any day now."
"The RBNZ riled against the inconsistency between tumbling export commodity prices and the very high exchange rate by saying "the level of the New Zealand dollar is unjustified and unsustainable and there is potential for a significant fall." We interpret this choice of language as a direct warning of intervention," Stephens said.
Stephens said there was a risk markets had over-reacted to the pause signal.
"The RBNZ intends this to be a hiatus within a broader trend of a rising OCR, but markets might come to believe that the RBNZ has lost its resolve to hike at all. If markets do overreact in this way, the RBNZ will seek to correct market pricing through speeches. RBNZ watchers should be wary," he said.
ASB Chief Economist Nick Tuffley said the New Zealand dollar's drop suggested markets viewed the "unjustified" comment about the New Zealand dollar as ticking a box to justify intervention.
"We don’t expect the RBNZ to intervene despite the comments, but the statement changes should keep the NZD heavy in the near term," Tuffley said, adding his view on a pause until December and a peak of 4.5% in the second half of 2015 had not changed.
"Within the intervention criteria it is primarily the “conditions in markets must be opportune and allow intervention a reasonable chance of success” criterion that is the stumbling block," he said.
Markets are now pricing in only 50 more basis points of hikes over 2015, which is much lower than the Reserve Bank's June MPS foredcast for a 4.5% OCR by the end of 2015.
Labour Finance Spokesman David Parker said the interest rate rise would hit the regions and put more upward pressure on the exchange rate.
"The regions are already hit by dropping export prices for dairy products and timber prices plus they have flat housing markets from LVRs. Now they have to endure another interest rate rise which is a direct result of the Auckland housing price bubble," Parker said.
"Home owners as well as exporters are now paying the price the price for the Government's failure to control the Auckland housing crisis. LVRs, lending restrictions and now interest rates heading towards 7% are shutting out first time home buyers," he said.
"The current Government's policies are driving a wedge between Auckland and the rest of the country."
Business NZ CEO Phil O'Reilly said a pause in the rate hikes was called for.
“With interest rates in the developed world at near-zero, we need to avoid adding pressure on the New Zealand dollar," O'Reilly said.
Parsing the statement
Today's decision was accompanied by its usual 'in-between' seven paragraph statement. Decisions made with a full quarterly Monetary Policy Statements (MPS) are accompanied by a full news conference and an appearance by the Governor before Parliament's Finance and Expenditure Select Committee.
It's worth comparing this statement with the opening statement in the June 12 MPS to see how the Reserve Bank's interpretation and thinking has changed.
July 24 - The Reserve Bank today increased the Official Cash Rate (OCR) by 25 basis points to 3.5 percent. New Zealand’s economy is expected to grow at an annual pace of 3.7 percent over 2014. Global financial conditions remain very accommodative and are reflected in low interest rates, narrow risk spreads, and low financial market volatility. Economic growth among New Zealand’s trading partners has eased slightly in the first half of 2014, but this appears to be due to temporary factors.
June 12 - The Reserve Bank today increased the Official Cash Rate (OCR) by 25 basis points to 3.25 percent. New Zealand’s economic expansion has considerable momentum, with GDP estimated to have grown by around 4 percent in the year to June. Global financial conditions remain very accommodative and are reflected in low long-term interest rates and narrow risk spreads. Economic growth among New Zealand’s trading partners is gradually improving and global inflation remains low.
The difference – The difference is in the apparently lower GDP growth figure, but the time periods are different. Reserve Bank officials made clear the 3.7% figure was an annual average growth figure for the calendar 2014 year. The bank did not include a direct comparable for calendar 2014 in its June MPS, but its annual average measure for the year to March 2015 was 3.5%, suggesting an increase in the bank's view of the growth rate.
July 24 -Construction, particularly in Canterbury, is growing strongly. At the same time, strong net immigration is adding to housing and household demand, although house price inflation has moderated further since the June Statement.
June 12 - Prices for New Zealand’s export commodities remain historically high, but their recent falls will reduce farm incomes over the coming year. A continued acceleration in construction in Canterbury, and more broadly, is supporting growth, together with strong net immigration flows that are adding to housing and household demand. Business and consumer confidence remains buoyant, as do businesses’ reported intentions to invest and to hire.
The difference – The paragraphs are a little different in content, given the last OCR decision included a mention of commodity prices. The bank shuffled that mention down this time to include it with a strong comment on the currency. There isn't too much different in the rest.
July 24 - Over recent months, export prices for dairy and timber have fallen, and these will reduce primary sector incomes over the coming year. With the exchange rate yet to adjust to weakening commodity prices, the level of the New Zealand dollar is unjustified and unsustainable and there is potential for a significant fall.
June 12 - The exchange rate has not yet adjusted to weakening commodity prices, but is expected to do so. The Bank does not believe the exchange rate is sustainable at current levels.
The difference: The tone of the Reserve Bank's warning about the currency is much tougher this time around, reflecting the sharp divergence between commodity prices and the currency. Intervention is not mentioned though, unlike in a speech Wheeler gave to dairy farmers in May, where he suggested it might become an option.
July 24 - Inflation remains moderate, but strong growth in output has been absorbing spare capacity. This is expected to add to non-tradables inflation. Wage inflation is subdued, reflecting recent low inflation outcomes, increased labour force participation, and strong net immigration.
June 12 - While house price inflation remains high, the housing market has moderated since late last year when restrictions were applied to high loan-to-value ratio mortgage lending and when mortgage interest rates began rising. Fiscal consolidation continues to moderate demand growth, though by less than previously assumed.
The difference – There's more discussion about moderate wage inflation in this statement.
July 24 - It is important that inflation expectations remain contained. Today’s move will help keep future average inflation near the 2 percent target mid-point and ensure that the economic expansion can be sustained. Encouragingly, the economy appears to be adjusting to the monetary policy tightening that has taken place since the start of the year. It is prudent that there now be a period of assessment before interest rates adjust further towards a more-neutral level.
June 12 - Inflationary pressures are expected to increase. In this environment, it is important that inflation expectations remain contained and that interest rates return to a more neutral level. The speed and extent to which the OCR will need to rise will depend on future economic and financial data, and its implications for inflationary pressures.
The difference – Today's statement included the bank's first comments about how "encouragingly" the economy had begun adjusting to the tightening.
July 24 - The speed and extent to which the OCR will need to rise will depend on the assessment of the impact of the tightening in monetary policy to date, and the implications of future economic and financial data for inflationary pressures.
June 12 - 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.
The difference – These paragraphs aren't directly comparable anymore, given the bank wove its outlook comment into the penultimate paragraph this time.
(Updated with Parsing of the statements and NZ$ fall to 86.1 USc, Economist comments, Politicians comments)