By Bernard Hickey
Financial markets are now expecting the Reserve Bank to cut interest rates again as soon as March after the bank delivered a clear easing bias in its first decision of the year and Fonterra surprised markets with an earlier-than-expected cut in its forecast payout to NZ$4.15/kg.
The Reserve Bank held the Official Cash Rate (OCR) at 2.5% as universally expected, but the focus was on its comments about the future and it delivered the clear easing bias for the rest of 2016 that most economists had expected.
Governor Graeme Wheeler said uncertainty about the global economy had increased because of concerns about China and other emerging markets. He also noted that headline inflation would now take longer to reach the Reserve Bank’s 1-3% target range than the Reserve Bank had forecast in its full December Monetary Policy Statement (MPS) forecasts.
“Some further policy easing may be required over the coming year to ensure that future average inflation settles near the middle of the target range,” Wheeler said in an eight paragraph statement with the bank’s first OCR decision of the year.
These comments represented a much clearer easing bias than the Governor’s comments on December 10, when he said of the bank achieving the middle of its 1-3% target range: “We expect to achieve this (target) at current interest rate settings, although the Bank will reduce rates if circumstances warrant.”
"The signal that the RBNZ may reduce the OCR was more forthright than markets anticipated," Westpac Chief Economist Dominick Stephens said.
The New Zealand dollar fell almost a full 1 USc to 64.2 US after the statement, although it also may reflect a cut in Fonterra's payout forecast to NZ$4.15/kg from NZ$4.60/kg. The jury is out on whether the next cut will be in March or June, with financial markets pricing in a 50% chance the rate cuts will restart in March. Wholesale 'swap' interest rates, which are the basis for fixed mortgage rates, fell 5 basis points after the decision.
Elsewhere, Wheeler said economic growth in New Zealand was expected to increase in 2016 because of continued strong net migration, tourism spending, solid construction activity and a lift in business and consumer confidence.
However, he said house price inflation in Auckland remained a financial stability risk and he repeated that the New Zealand dollar was still too high.
“There are signs that the rate of increase (in Auckland) may be moderating, but it is too early to tell. House price pressures have been building in some other regions,” Wheeler said.
The mention of other regions was the first time the Governor has mentioned the spreading of house price inflation into other regions in his initial set-piece statement, suggesting the bank is becoming more concerned about the double-digit inflation now spreading into the likes of the Waikato and Bay of Plenty. Some economists have warned the Reserve Bank may widen its lending restrictions for landlords if it became concerned about inflation elsewhere.
Wheeler said there had been some easing of financial conditions in New Zealand in recent weeks with a fall in the New Zealand dollar and market interest rates.
“A further depreciation in the exchange rate is appropriate given the ongoing weakness in export prices,” Wheeler said.
He said headline CPI inflation remained low due to falling fuel prices, but the Governor noted core inflation and inflation expectations were not falling.
“However, annual core inflation, which excludes temporary price movements, is consistent with the target range at 1.6 percent. Inflation expectations remain stable,” he said.
Financial markets have increased their expectations of further OCR rates as soon as March, with some economists predicting the Reserve Bank will have to cut the OCR to 2.0% by the middle of the year.
The Reserve Bank’s statement ‘in between’ full Monetary Policy Statements does not include fresh forecasts for inflation or interest rates so it’s not clear how the Reserve Bank’s own expectations have changed. It forecast the OCR would be flat at 2.5% until 2018 in its December 20 statement, although its comments today about “some further easing may be required” and its note about its headline inflation expectations falling since December suggest its own OCR rate forecasts have fallen.
The next full set of forecasts are not due until March, although Wheeler is expected to flesh out the bank’s views in a luncheon speech next Wednesday.
ASB Chief Economist Nick Tuffley said the Reseve Bank delivered a clearer easing bias, "but not an explicit signal that the RBNZ will necessarily cut the OCR as soon as March."
"But, importantly, the RBNZ is very conscious of the growing downside risk to the inflation environment," Tuffley said, adding he expected the Reserve Bank to cut the OCR to 2.0%, starting from June.
"The risks to that forecast remain a slightly earlier start," he said.
"The threshold for a March OCR cut still appears high in the wake of the January statement, The RBNZ still seems too relaxed about the inflation risks, but events could yet prompt a move then. The April OCR window follows the Q1 CPI, and further signs of weak inflation pressure could be a green light at that point," he said.
Westpac Chief Economist Dominick Stephens said the Reserve Bank had shifted to an explicit easing bias, but was not explicit about the likely start date for further cuts. Stephens said the statement could support cuts starting in either March or June. He now expected the rate cuts to resume in March, whereas he had previously thought they would start in June.
Westpac now expected annual inflation to fall to 0% by September of this year.
"As an inflation targeting central bank, there was no way the RBNZ could ignore such a monumental change in the inflation outlook," Stephens said.
ANZ Chief Economist Cameron Bagrie said the statement delivered a more explicit easing bias than the conditional one delivered in December, although it was not one way traffic. He pointed to the bank's comments about solid growth, house price inflation risks and a lower New Zealand dollar.
"This doesn’t sound like a central bank ready to cut rates any time soon. But the door is open, and markets will run with it," Bagrie said.
"While the easing bias has been “stepped up”, the Bank stopped short of setting the scene for a March cut, so it is difficult to argue with markets when odds of a March cut sit at around 50/50," he said.
BNZ Head of Research Stephen Toplis stuck to his view that the Reserve Bank was more likely to remain on hold than cut, "but given the stated easing bias and the obvious risks that prevail it is easy to justify current market pricing and betting against it is unlikely to offer great reward in the very near future."
"The Bank spent some time highlighting why rates should not be cut now. In particular, this was the first time (that we can remember) that the RBNZ has specifically referred to core inflation in its OCR/MPS press statements," Toplis said, pointing also to the bank's statement about stable inflation expectations.
"The combination of these statements is a very strong warning to all and sundry that the RBNZ will not pander to pressure to lower its cash rate just because headline inflation remains low," he said.
"Equally, it is a reminder that if headline inflation stays low and reduces inflation expectations to the extent that economic behaviours threaten to push the core rate down further then the RBNZ will respond to this by cutting rates," he said.
"Given that the RBNZ is looking for weakening inflation expectations to feed into core inflation as a catalyst for further easing then it would seem that any prospective rate cut, were it to happen, is more likely to occur later in the year than sooner given the lags involved."
First NZ Economist Chris Green changed his OCR view after the decision, which he described as adopting a more explicit easing bias. He said he now saw one or two 25 basis point cuts over 2016, rather than the OCR remaining on hold. He said the March 10 MPS may be too early, given a lack of fresh domestic data, and he had pencilled in one cut for the June MPS.
New Zealand First Leader Winston Peters said the Fonterra payout cut threatened an economic storm.
“The Prime Minister’s answer is consumptive policies in Auckland and an abandonment of productive polices for the rest of the country," Peters said.
“Our government has done less than nothing to help provincial NZ which is the foundation of our export wealth. Historically this must be the worst National government for New Zealand farmers and with the chickens coming home to roost, they’re paying the price for what is now a party dominated by city slickers," he said.
Labour Finance Spokesman Grant Robertson called on the Government to take action on the economy.
"The drop comes a day after Fitch ratings agency revised our near term growth prospects downward because of declining prices for dairy exports and on the same day the Reserve Bank said dairy prices remain a risk," Robertson said.
“The Reserve Bank Governor can’t fix the economy on his own. He’s stuck between the rock of low inflation and falling growth and the hard place of the Auckland housing market," he said.
“New Zealand needs a more diversified economy to help insulate us from major commodity shocks. We need to invest in job-rich industries and support companies to move up the value chain. We can also bring forward projects to stimulate the economy. Despite more than a year of warnings as dairy prices have plummeted there has been no real effort from the Government to do this."
Green Finance Spokeswoman Julie-Anne Genter said the Reserve Bank would have been able to the cut the OCR without its concerns about the Auckland housing market, which the Government was not doing enough to address.
“National hasn’t done enough to take the heat out of the Auckland housing market and John Key’s big speech yesterday showed that National has no new ideas for how to fix the housing crisis," Genter said.
"We need Government-backed affordable housing developments, quality intensification along key transport routes, and a capital gains tax (excluding the family home),” she said.
Here is the Reserve Bank’s full statement today:
The Reserve Bank today left the Official Cash Rate unchanged at 2.5 percent.
Uncertainty about the strength of the global economy has increased due to weaker growth in the developing world and concerns about China and other emerging markets. Prices for a range of commodities, particularly oil, remain weak. Financial market volatility has increased, and global inflation remains low.
The domestic economy softened during the first half of 2015 driven by the lower terms of trade. However, growth is expected to increase in 2016 as a result of continued strong net immigration, tourism, a solid pipeline of construction activity, and the lift in business and consumer confidence.
In recent weeks there has been some easing in financial conditions, as the New Zealand dollar exchange rate and market interest rates have declined. A further depreciation in the exchange rate is appropriate given the ongoing weakness in export prices.
House price inflation in Auckland remains a financial stability risk. There are signs that the rate of increase may be moderating, but it is too early to tell. House price pressures have been building in some other regions.
There are many risks around the outlook. These relate to the prospects for global growth, particularly around China, global financial market conditions, dairy prices, net immigration, and pressures in the housing market.
Headline CPI inflation remains low, mainly due to falling fuel prices. However, annual core inflation, which excludes temporary price movements, is consistent with the target range at 1.6 percent. Inflation expectations remain stable.
Headline inflation is expected to increase over 2016, but take longer to reach the target range than previously expected. Monetary policy will continue to be accommodative. Some further policy easing may be required over the coming year to ensure that future average inflation settles near the middle of the target range. We will continue to watch closely the emerging flow of economic data.
For comparison’s sake, here is the Bank’s statement from December 10.
The Reserve Bank today reduced the Official Cash Rate (OCR) by 25 basis points to 2.5 percent.
Globally, economic growth is below average and inflation is low, despite highly stimulatory monetary conditions. Financial markets remain concerned about weaker growth in emerging economies, particularly in China. Markets are also focused on the expected tightening of policy in the United States and the prospect of an increasing divergence between monetary policies in the major economies.
Growth in the New Zealand economy has softened over 2015, due mainly to lower terms of trade. Combined with increases in the labour supply from strong net immigration, the slowdown has seen an increase in spare capacity and unemployment.
A recovery in export prices, the recent lift in confidence, and increasing domestic demand from the rising population are expected to see growth strengthen over the coming year. The New Zealand dollar has risen since August, partly reversing the depreciation that occurred from April. The rise in the exchange rate is unhelpful and further depreciation would be appropriate in order to support sustainable growth. House price inflation in Auckland remains high, posing a financial stability risk.
Residential building is accelerating, and recent tax and LVR measures are expected to reduce housing pressures. There are some early signs that Auckland house price inflation may be moderating. CPI inflation is below the 1 to 3 percent target range, mainly due to the earlier strength in the New Zealand dollar and the 65 percent fall in world oil prices since mid-2014.
The inflation rate is expected to move inside the target range from early 2016, as earlier petrol price declines will drop out of the annual calculation, and the lower New Zealand dollar will be reflected in higher tradables prices. There are a number of uncertainties and risks to this outlook. In the primary sector, there are risks that dairy prices remain weak for longer, and the current El Nino results in drought conditions and weaker output.
Risks to the domestic outlook include the prospect of net immigration staying high for longer and of household expenditure picking up on the back of strong house prices. Monetary policy needs to be accommodative to help ensure that future average inflation settles near the middle of the target range.
We expect to achieve this at current interest rate settings, although the Bank will reduce rates if circumstances warrant. We will continue to watch closely the emerging flow of economic data.
(Updated with full statements, details, market reaction, political reaction)