The Governor of the Reserve Bank of New Zealand (RBNZ) is expected to leave the Official Cash Rate (OCR) at 3.50%, when it's reviewed on Thursday (April 30).
This will make it the sixth straight review where the OCR has been left unchanged following four straight increases, that added a combined 100 basis points, before the RBNZ's much heralded tightening cycle came to an abrupt end in July last year.
While the tone of the RBNZ’s March Monetary Policy Statement (MPS) was neutral, with Governor Graeme Wheeler firm on his ‘the OCR could go up or could go down’ stance, bank economists say the RBNZ’s now indicating the OCR's more likely to drop than rise, when it finally moves.
“The conditions are ripe for the RBNZ to soften its tone… a further softening in tone is not just warranted, it is likely”, says ANZ chief economist Cameron Bagrie.
Westpac chief economist, Dominick Stephens, says the speech RBNZ Assistant Governor John McDermott delivered on inflation indicates the tone of the comments in this OCR review will be “more dovish” than those that accompanied the March MPS.
“The cat is already out of the bag. Next week’s OCR review can only serve to affirm this change of stance”, Stephens says.
“We ascribe a 40% chance to OCR cuts this year.”
BNZ senior economist Craig Ebert says; “The more we delved into the speech, the more it offered up some soft touches, at the edges. These suggested that if there was a bias for the OCR between now and the end of the year, it is more likely down than up.”
ASB chief economist Nick Tuffley says; “We still think there is a 25% chance the RBNZ cuts the OCR this year”.
A rock and a hard place
The RBNZ is essentially between a rock and a hard place.
Stephens says; “Near-zero inflation, dimming prospects for primary exporters, and an extremely high trade-weighted exchange rate all argue for OCR cuts."
“But cutting the OCR would risk turbo-charging the already-hot domestic economy, thus generating a future inflation issue. Auckland house prices are roaring higher, construction activity is booming, net immigration is running at all-time highs, and consumers are on a spending spree.”
Statistics NZ figures out earlier this month showed inflation for the year to the March quarter at a 16-year low of 0.1%, and consumer prices down 0.3% in the March quarter. The RBNZ is tasked with maintaining annual increases in the Consumers Price Index of between 1% and 3% on average over the medium term, with a focus on keeping future average inflation near the 2% target midpoint.
However, the Auckland housing market is running red hot. The latest Real Estate Institute of New Zealand (REINZ) monthly sales figures, for March, showed fresh national and Auckland median price records, and the strongest sales volumes in any month since May 2007.
In the red hot Auckland market the March median sales price of $720,000 smashed the previous record high by $42,000, or 6.2%. The Auckland median price rose 13% in the year to March, and 11% in the three months to March. And the REINZ Stratified Housing Price Index, which adjusts for some of the variations in the mix that can affect the median price, showed a 20% annual rise in its Auckland Index.
Meanwhile, with New Zealand's relative economic strength compared to many other countries, and higher interest rates, the Kiwi dollar remains strong against the likes of the Aussie dollar, green back and euro. As of Friday afternoon, the Trade Weighted Index (TWI) was at 80.2, about 4.5% above the RBNZ’s MPS second quarter assumption.
Economists expect the RBNZ to prioritise the eye-wateringly high dollar above Auckland’s housing crisis, and leave the latter to the Government to deal to, to some extent.
Tuffley says the speech Deputy Governor Grant Spencer delivered earlier this month “revealed the RBNZ sees limited scope for any of its toolkit to influence the housing market much and has put the onus on local and central government."
“Importantly, we don’t think the strength of the housing market would stop the RBNZ from cutting the OCR if the inflation outlook warrants further stimulus.”
Tuffley explains; “If the inflation outlook weakened and a return to the target bank came under question, we don’t see housing as an impediment to the RBNZ dropping interest rates."
“Monetary policy objectives will dominate when it comes to the OCR. But there would be some gritting of teeth as a lower OCR would increase the RBNZ’s concerns about financial stability.”
At March's MPS press conference Wheeler himself ruled out the strong Auckland housing market as a reason why the RBNZ didn't cut the OCR. Wheeler said the RBNZ wasn't seeing the same wealth effects on consumer spending and CPI inflation as was seen during the 2002 to 2007 housing boom when households used their surging home equity as an ATM for a spending spree that pushed up consumer prices.
Fed rate hikes distant?
In terms of the dollar's strength, Tuffley notes problematically, it's across all key currencies.
“US interest rate increases look slightly more distant. The impact of the ECB’s quantitative easing has weakened the euro markedly," says Tuffley.
“Australia’s economy is still struggling to rebalance with a further cash rate cut possible next month. Even the UK Pound is catching turbulence, with its General Election looming.”
Financial markets expect the US Federal Reserve to increase interest rates sometime this year for the first time in nine years. The Fed Funds Rate, the US OCR equivalent, is currently at 0% to 0.25%.
However the downward influences on the economy are worth noting, according to ANZ's Bagrie.
“Our base case (and most likely the RBNZ’s) is that growth will remain around 3%, which is more or less where we see the trend”, says Bagrie.
“Christchurch’s growth impetus is waning and its housing market is slowing, removing an obvious inflation risk and leaving Auckland as the sole problem."
“The low dairy payout this season is of course well appreciated. However the failure of dairy prices to recover meaningfully is increasing the very real prospects of a second consecutive low payout in 2015/16."
“The implications for farm cash-flow are stark. Other commodity prices are also showing signs of turning," Bagrie says.
Tuffley adds there are also still question marks over the extent of China’s growth deceleration and the Greek Government’s determination to push the threat of default to the brink.
But on the upside, New Zealand migration figures are strong, with net migration surging to a new record high in March.
In terms of inflation, Tuffley points out that despite the recent CPI inflation result being slightly stronger than the RBNZ had expected, it isn’t out of the low inflation woods yet.
“The RBNZ’s primary concern is that low headline inflation, while temporary, could start to influence inflation expectations and in turn, wage-and-price-setting behaviour”, says Tuffley.
“And so it’ll be important to watch the wage and salary data, and the various business pricing and inflation expectations variables, like a hawk. Or should we say, like a dove?” says Ebert.
“If the Reserve Bank were to cut the OCR, it would most likely occur late in the year, for two reasons”, says Stephens.
“First, compelling evidence of falling inflation expectations won’t really be available until at least the middle of this year."
“Second, macro-prudential tightening is one possible resolution to the monetary policy conundrum."
“The RBNZ has indicated that it will restrict mortgage lending to landlords. However, implementing such restrictions is infeasible until later in the year. The RBNZ may be loath to cut the OCR until it is comfortable that the housing market can be contained another way," Stephens says.
Stephens continues, “Given that the cat is already out of the bag, the scope for a market reaction next week is now limited."
“Markets reacted vigorously to the [McDermott’s] speech, sending swap rates five basis points lower, and the New Zealand dollar down by three-quarters of a cent."
“One struggles to imagine how a one-page press release could contain new information over and above a nine-page speech delivered only one week earlier."
“However, the reality of financial markets is such that the exact words that the RBNZ chooses next week could cause some degree of price action," Stephens suggests.