By Bernard Hickey
The Reserve Bank of New Zealand left the Official Cash Rate on hold at 2.25% on Thursday morning, as most local bank economists had expected, and has repeated its guidance that 'further policy easing may be required.'
The Reserve Bank's 90 day bill forecasts suggest the bank is planning at least one more OCR cut to at least 2.0% some time over the next three months, before being unchanged until the end of the forecast period in June 2019. The forecast track has barely changed from the bank's March quarter forecasts.
The New Zealand dollar immediately jumped over almost a cent to over 71 USc and sits as much as 5% above the Reserve Bank's new forecast for the Trade Weighted Index for the September quarter. If the currency stays this high, the Reserve Bank itself forecast a scenario where it would have to lower the OCR to under 1% to lower the currency to meet its inflation forecasts.
In deciding not to cut now, Governor Graeme Wheeler said global financial market volatility had eased and the domestic economy was supported by strong net migration, construction, tourism and "accommodative monetary policy."
He said the New Zealand dollar was higher than was appropriate, but he noted that Auckland house prices were very high and that house price inflation in Auckland and other regions was adding to the bank's concerns about financial stability. He added more housing supply was needed.
Wheeler said long term inflation expectations were well anchored at 2% and that short term inflation expectations had stabilised after dropping. He said the bank expected inflation to strengthen.
"We expect inflation to strengthen reflecting the accommodative stance of monetary policy, increases in fuel and other commodity prices, an expected depreciation in the New Zealand dollar and some increase in capacity pressures," Wheeler said in a statement with the decision.
"Monetary policy will continue to be accommodative. Further policy easing may be required 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," he said.
'6 years below target mid-point'
Economists at three of the big four banks (ANZ, BNZ, and Westpac) expected no change, while ASB had seen a very close decision to cut to 2.0%. But overseas economists had been much more confident about a cut. A Bloomberg survey found 8 out of 15 economists expected a cut, with most of those based overseas. Financial markets had seen a 25% chance of a cut, which helped explain the sharp move in the currency immediately after the decision.
From a purely inflation targeting point of view, the Reserve Bank has been under intense pressure to cut the Official Cash Rate, possibly as low as 1.5% as some have said (BERL and CBA) to get CPI inflation back up near the 2% midpoint of the Governor's Policy Targets Agreement with Bill English. Annual CPI inflation has been below the 2% midpoint since September 2011 and has been below the 1% bottom of the bank's 1-3% range since September 2014.
In March the Reserve Bank forecast annual CPI inflation would not return to 2% until March 2018. In this Monetary Policy Statement the bank forecast inflation would return to 2.0% in the December quarter of 2017, which would mean CPI inflation below the 2% midpoint for 6 years.
The Reserve Bank forecast annual CPI inflation would rise from 0.4% in the March quarter of this year to 1.3% by the December quarter of this year. That would imply annual CPI inflation had been below the 1% lower bound of the bank's target range for just over two years.
One scenario suggests 0.75% OCR
The Reserve Bank did however suggest the possibility of significantly lower interest rates if the New Zealand dollar did not fall as the Reserve Bank expects.
It included a scenario in the Monetary Policy Statement where the currency did not fall, which would leave it 4% higher than the bank's central projection. It said that would force the bank to cut the OCR lower than its central projection.
It published a 90 day bill track showing it falling from just over 2.0% in the central projection to just under 1%, which would imply an OCR as low as 0.75%.
Its other 'high' scenario looked at what the bank would have to do if house price inflation was higher than expected and that translated into higher household consumption. This scenario included house price inflation being as much as 5 percentage points higher than its central scenario, which would force the bank to lift 90 day bill rates to over 3% by the end of the scenario.
Economists said in their initial reactions to the statement, which was the first without a lockup in decades because of an embargo breach by Mediaworks in March, that the Reserve Bank appeared more confident about inflation rising.
"Our overall conclusion was that the RBNZ is feeling less alarmed about low inflation than it was a couple of months ago, but that it still views another OCR cut as likely to be required," Westpac Chief Economist Dominick Stephens said.
ASB Senior Economist Jane Turner said financial stability concerns appeared to have influenced the decision not to cut.
"The RBNZ may be stalling to allow time to introduce further macro-prudential tools," Turner said.
"We continue to see downside risks to the RBNZ’s inflation outlook. As a result, we continue to expect the cash rate to eventually fall to 1.75%, although the RBNZ appears very reluctant to cut rates," she said.
ANZ Chief Economist Cameron Bagrie said the Reserve Bank appeared to be playing a game of chicken with the Kiwi dollar and saw the chances of a cut in August at just over 50%.
"Importantly, the RBNZ is again highlighting that housing market as a financial stability risk. This not only sets the bar higher to future easing, but signals that additional macro-prudential measures continue to be more likely than not," Bagrie said.
He said the bank's steady currency scenario meant there was a limit to how high the New Zealand dollar could go.
"We note that the Bank’s downside scenario (which takes the 90 day bill rate below 1%, pointing to an OCR at 0.75%) is associated with the TWI holding steady, rather than rising, suggesting the currency hurdle to easing is not overly high (especially if housing can be cooled via macro-prudential policy). In other words, we’re back to MCI trading," he said.
Labour Finance Spokesman Grant Robertson said the Government's failure on housing had forced the Reserve Bank to hold and Wheeler's comments about very high Auckland house prices and the need for extra housing supply was a blunt warning and a shot across the Government's bow.
“New Zealand needs to build more houses now. Labour will do this through our KiwiBuild programme that will see at least 100,000 affordable homes built," Robertson said.
“The Reserve Bank Governor has a mandate to keep inflation at 1 – 2%. It’s well below that now. He is being constrained from cutting the OCR to meet his target because the Government isn’t doing its job on housing," he said.
"National has lost control of the housing crisis. The only way to get on top of it is to change the government, and implement Labour’s plan to build more houses and crack down on the speculators National has been happy to indulge.”
(Updated with market reaction, economist reaction and more detail)
Here is the full statement below:
The Reserve Bank today left the Official Cash Rate unchanged at 2.25 percent.
Global financial market volatility has abated and the outlook for global growth appears to have stabilised after being revised down successively over recent quarters. There has been a modest recovery in commodity prices in recent months. However, the global economy remains weak despite very stimulatory monetary policy and significant downside risks remain.
Domestic activity continues to be supported by strong net immigration, construction, tourism and accommodative monetary policy. The dairy sector remains a moderating influence with export prices below break-even levels for most farmers.
The exchange rate is higher than appropriate given New Zealand’s low export commodity prices. Together with weak overseas inflation, this is holding down tradables inflation. A lower New Zealand dollar would raise tradables inflation and assist the tradables sector.
House price inflation in Auckland and other regions is adding to financial stability concerns. Auckland house prices in particular are at very high levels, and additional housing supply is needed.
There continue to be many uncertainties around the outlook. Internationally, these relate to the prospects for global growth and commodity prices, the outlook for global financial markets, and political risks. Domestically, the main uncertainties relate to inflation expectations, the possibility of continued high net immigration, and pressures in the housing market.
Headline inflation is low, mostly due to low fuel and other import prices. Long-term inflation expectations are well-anchored at 2 percent. After falling in recent quarters, short-term inflation expectations appear to have stabilised.
We expect inflation to strengthen reflecting the accommodative stance of monetary policy, increases in fuel and other commodity prices, an expected depreciation in the New Zealand dollar and some increase in capacity pressures.
Monetary policy will continue to be accommodative. Further policy easing may be required 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.