The Reserve Bank surprised financial markets by saying it does not expect the next OCR move to be until 2020, but why has Governor Orr suddenly become so much more dovish?

It is probably fair to say Reserve Bank Governor Adrian Orr surprised a lot of people on Thursday morning.

The Kiwi dollar fell to a near two year low and after the release of the Monetary Policy Statement (MPS) and bank economists detailed their shock in economic notes. The dollar dropped 100 basis points, and at the time of writing was at US66.84 cents. Wholesale swap rates also tumbled, down about 10 basis points across the rate curve. 

The main theme coming through in the hours after the MPS was released was that it was a “dovish statement.”

“We expect to keep the OCR [Official Cash Rate] at this level [1.75%] through 2019 and into 2020, longer than we projected in our May Statement,” Orr said.

The reason for the surprise and the sizeable drop in the currency was because this is a significant shift in timing.

In May, the Reserve Bank was forecasting the OCR would rise in September 2019. Orr had pushed back the timing of the hike by one quarter, compared to November’s MPS.

On Thursday, Orr had pushed out his expectations for an OCR change by an entire year.

This goes much further than all the major bank economists’ forecast.

“We had expected the RBNZ to sound a little more ‘dovish’ in the statement – but in the end, the RBNZ was considerably softer in its outlook for inflation and interest rates,” ASB said in a research note.

“We are surprised by the degree of reaction from the RBNZ today,” Westpac Senior Economist Michael Gordon said after the MPS was released.

So what’s behind the Governor’s much more dovish stance?

“The difference is we see [the OCR] being lower for longer,” Orr told the MPS media conference.

“The recent slower economic growth gives us more confidence that there is no immediate capacity pressure leading to the rising inflation.”

Economic growth has slowed recently, the MPS says. Annual GDP growth was 2.7% in the March 2018 quarter, down from over 4% in mid-2016.

August's MPS forecasts the economy to grow at 2.8% over the coming year - that's 0.5% lower than its estimates in May's MPS.

Growth estimates vary between forecasters, but there is a general consensus the New Zealand economy has shifted down a gear.

Orr says economic growth is expected to pick up to above trend levels in 2019, but there are two major reasons for this.

“Fiscal and monetary stimulus underpin this growth outlook,” Orr says.

Simply put, keeping the OCR “lower for longer” while the Government is putting money back into people’s back pockets through the Families Package is expected to keep growth humming along.

“The OCR setting is based on how we see the economy evolving and part of that is the Government’s investment intentions,” Orr says.

A sugar hit

This does not sit well with National’s Finance Spokeswoman Amy Adams, who says this is simply masking the underlying picture of the economy.

“The Minister of Finance has talked repeatedly about building a productive and sustainable economy; if your growth is only held up by Government spending, that is nether productive nor sustainable.”

She says having both monetary and fiscal policy being so stimulatory does nothing to support an actual increase in productivity of the real economy.

“It’s a sugar hit, it isn’t truly sustainable growth in the economy.”

Meanwhile, Orr has yet again made it clear he thinks the next OCR move “could be up or down.”

“We believe the risks [to the economy] are balanced, hence the ‘up or down’ next move on the OCR,” Orr says.

He says the upside risks to the OCR is inflation, and inflation expectations, which “could get away quicker than we project.”

The challenge in this area, he says, is margin pressures in business that could be passed on into higher prices which could, in turn, lead to higher inflation.

On the downside risks – “we’re well aware of business confidence levels being low.”

But he says the Central Bank spends more time focusing on the firms’ own activity, which in the most recent ANZ data was at the lowest levels since the Global Financial Crisis.

Because of this, the Reserve Bank has a “more muted investment cycle projected, but our growth could take longer to pick up than what we project through that side.”

A 'stridently dovish' RBNZ 'shocks & Orrs'

In his note on the MPS, entitled RBNZ Stridently Dovish, BNZ Head of Research Stephen Toplis said the new Orr-led regime has revealed its spots.

"The question going into it [the MPS] was would the Governor be more concerned about the weakening growth indicators or would he be more bothered by the upward trend in both core and headline inflation? The answer is now there for all to see - weak growth won the day. Inflation forecasts were, on balance, little changed but this was not enough to prevent the RBNZ lowering its interest rate track," said Toplis.

"The scenario analysis in the MPS also reveals the [Reserve] Bank’s dovish biases. Under the Bank’s higher inflation scenario it raises the cash rate by 50 basis points more than its central scenario. However, was growth to surprise on the downside, the door is open to a 100 basis point cut."

"Ultimately, we think the Bank is going to get both of these outcomes – namely lower growth and higher inflation. However, the Bank has low-balled its near-term growth forecasts so any downside surprise is unlikely to show up until calendar 2019. Indeed, near term we see upside risks to both the Bank’s growth and inflation forecasts. Consequently, we think there is little chance that the data will give markets the chance, near term, to price in a full 25 basis point cut," Toplis added.

"We have been warning for some time that we might need to delay our first rate hike prediction so we are, today, taking the opportunity to formally push back our forecast first rate hike to August 2019 from May 2019. We have also lowered the peak in our interest rate track to 2.75% from 3.00%."

And in his note entitled Shock and Orr, Kiwibank chief economist Jarrod Kerr said the main message from the Reserve Bank was one of heightened uncertainty, with downside risks prevailing. Kiwibank's economists have pushed out their expectations for an OCR increase to May 2020, from Aug 2019.

"The Governor continued to deliver a positive feel during the media conference, but the numbers in the MPS are blatantly dovish. It’s time to watch, worry and wait," said Kerr.

"The big news here is the reaction is financial markets to the dovish signals. The Kiwi dropped over 1% to $0.6680 against the Greenback. The two-year swap rate dropped 6 basis points immediately, to ~2.055%, at time of writing. Orr noted he was 'very pleased with the performance of the currency. It’s as close to fair value as it gets.' Along with our change in OCR forecast, pushing it out a few months, we have lowered or swap rate forecasts and Kiwi dollar forecasts."

"The Kiwi looks like an endangered species, and we see the bird hitting 0.65c by year end, down from 69c previous forecast, and 63c in mid-2019, down from 67c. So we forecast the Kiwi moving in the same direction, down, but now much lower. Our rate forecasts are also lower, and curve outlook steeper, despite today’s awkward move," Kerr added.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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40 Comments

Isn't the slowdown because of the following?:
a) lower capital inflow from China due to their purge on capital flight
b) lower capital inflow via the Aussie banks due to RBA and RBNZ stealth capital controls (loan to value ratio, core funding ratio etc).

Result, less upward pressure on house prices and a moderating of the exchange rate leading to a rebalancing away from house shopping (construction being a form of made to measure shopping) towards export goods and services.

Exactly.

And when your productive sector has been hollowed out over an extended period, the rebalancing takes quite some time and quite a lot lower currency to achieve.

Relax, the burgeoning avocado sector will carry the economy on its broad shoulders...

Maybe we can buy some old diesels and run them on avocado oil.

No reason new diesels cant run on avo oiĺ!

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12

Amy Adams a keen appreciator of irony: “It’s a sugar hit, it isn’t truly sustainable growth in the economy.”

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14

Well, they should by now be the experts on what doesn't constitute sustainable productivity growth.

RickStrauss, maybe Adams can no longer recall that her own party proposed a "sugar hit" by way of tax cuts to secure votes......

Actually tax cuts tend to get modeled as a short term reduction to tax take followed by an increase in overall tax take. A business that gets to keep more of its income has more money to invest into growth which results in yet more income to invest. I believe that it is generally acknowledged that taxation inhibits economic growth.

Tax cuts are therefore more like a slow acting fertiliser as opposed to a quick sugar hit.

Tax cuts would be fine (notwithstanding infrastructure pressures) if we have a regimen that won't simply push more money into already inflated asset prices rather than productive enterprise. in the USA, the cuts are simply being pushed into stock buy-backs rather than productive investment.

Drop personal and corporate income taxes significantly while raising land tax and you might see some actual investment in productive enterprises resulting in real growth.

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if your growth is only held up by Government spending, that is nether productive nor sustainable

Leaders of the Nat party are undoubtedly the experts in productivity and sustainable economic growth.

JK and BE gave us a great illusion of strong economic growth but were all those years quietly sliding the poop from excessive migration and property speculation under the carpet. The incumbents are now left with a rotting mess to clean up in a post-cycle phase.

I am sure Key saw this s**t storm coming from miles away and decided to jump ship instead of running for office again.

Cut the Cr-- The Reserve Bank is calling as it is, it has to deal with this Govt's lack of Business and Economic direction.
Previous Governor have tried to get our Dollar down in value. the Economic direct of the COL has achieve that in 10 months.
Tome to ditch Academic theory of front line action.

Weaker dollar, should lead to higher prices for consumers but what will happen is that we will see the pressure on volumes which will be lower (weaker growth because of tighter household finances) and will lead to significantly more discounting of margins by retailers to attract sales. neutral inflation outlook where the pain will be born by the retailers. The country needs the weaker dollar though to boost export earnings. Mr Orr so far has got things absolutely spot on. Hopefully the collateral damage in the retail sector will be minimal, the more efficient businesses will be fine.

“Simply put, keeping the OCR “lower for longer” while the Government is putting money back into people’s back pockets through the Families Package is expected to keep growth humming along.”

Ah yes, redistribution, the best method to keep growth “humming.”

RBNZ TWI forecast for September, in February 75.0, May 74.1, August 73.0. Currency markets show RBNZ up a river without paddles.

Woah. Big sell off in NZ dollar today and that's with a lot of the FX markets still in bed.

can’t see how Orr can predict GDP growth will take a 90 degree turn anytime soon. GDP growth has been in freefall since election time. The graph above even predicts GDP output to fall. Disconnect?

With Akl house prices now stable to falling this is far from a "sugar hit". Growth comes primarily from business expansion by using equity in the house.

WFF for family’s tax credits will get gobbled up by Foodstuffs, Z Energy and Goff.

Likewise inflation will pick up with our $ continuing to depreciate, and the minimum wage adjustments kicking in.

Now that the world sees us as a banana republic again farmers, will get to enjoy higher earnings, whilst the domestic economy flounders.

C'mon Cowpat. When did the currency markets show us anything that meant anything for more than five minutes? If you can show how previously-elevated exchange rates were anchored by solid and sustainable economic activity well and good. But they weren't.

Cowpat | Wed, 08/08/2018 - 18:19
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The bounce in the NZD following the M13 data , was quite pronounced, although at the time the currency markets were marking time.. Once the underlying data as David notes is absorbed overnight the gains should be quickly reversed.
Rhumline the fx markets are always suggesting lots of things in many timelines. My comment was simply an indication that we give the RBNZ and indeed company boards far too much deference in regard to their forecasting abilities. The data speaks for itself.

I guess he just wants the NZD to be worth less. I imagine young people with deposits will be selling their NZD as fast as possible - I know I already have. He's living in la-la-land if he expects a rush of young people (namely FHB's) into this joke of a housing market, especially in 2020 when he'll raise rates.

God loves a trier.

Tipping point? We'll see. The two main factors are the globalists and the localists. Both are looking a bit shaky it has to be said. One is beyond our control - like the weather - the other has 100 odd committees trying to figure out where we are and what to do. This is quickly turning into a lost opportunity year for NZ Inc.Will the decision-making get any better? Let's hope so, for all our sakes.

Now we know 'What's got Adrian Orr so dovish'

Fonterra!

Ever heard of something called information asymmetry ?

Basically we dont know what he knows .

But he knows something is up, or something is unfolding , or he has a plan up his sleeve .

Is our economy overheating , or showing sign of doing so ?

Or is it slowing ?

He seems to think its slowing

From a global perspective , its either that the global economy is looking shaky OR he wants our interest rates to be low enough to cause overseas investors to start withdrawing , thus weakening the Kiwi $ .

Its a good time to have some NZ$ weakness , Dairy prices are flat for one , and we need to stimulate other export sectors.

Spot on Boatman.

Spot on Boatman

Spot on imhenry.

Spo

Spot on Nzdan

Maybe he Knows that the predicted $11 billion hole is worse than feared.

G Bagrie has just worked it out.Not sure why Interest.co hasn't caught up.
Today maybe?

getting some coverage ....

Markets
Asia Stocks Mixed on Trade Volleys; Kiwi Slumps: Markets Wrap
https://www.bloomberg.com/news/articles/2018-08-08/asia-stocks-signal-de...

Note that the Aussie and NZ sharemarkets have soared today.

Orr's announcement today might spark some renewed interest in the housing market.....

Prospects for term deposits are bleak. )-;

TTP

NZ is always going to go backwards when we have a government made up of politicians that have very little business acumen and no idea on how to run a business.
Give more money to the people that don’t have as much as others is their idea on how to do things!
Reality is that this only encourages more mediocrity from many and doesn’t encourage people to improve their own lot.
Business will struggle under this government for the next couple of years until National get voted back in.
KiwiBuild? What is happening here?
Where is Mr Phil Stoner Twyford?
KiwiBuild, I hope people are still saving for the deposit on the KiwiBuilds that no one knows what they are!!!

Yeah, you're right, this is the result of nine years of subsidising property investors and company wage bills, pumping money into the property market and relying on twice the OECD norm immigration to prop things up.
Supposed business acumen but lacking the ability or willingness to translate it into economic policy.

Bot your in a dark place.

I think your opening comment could equally be directed at at the previous bunch of preening wallies? As much as I don't think this Government has got the nous (yet) to close the gap between what business wants and all those who were left behind over the past 9 years, I'll give them the benefit of the doubt.

It was after all the previous government that created the conditions that the kids are now trying to grapple with.

In the meantime, your argument about mediocrity is trite and not borne out by evidence. Turns a blind eye to the waste and sheer incompetence that characterised much of National's turn in office (Nick Smith, Gerry Brownlie - c'mon give me a break!)

Short of selling assets (some of the public most of them private) to 'new New Zealanders' and borrowing big to build more motorways, could you remind me what made the last lot such standout performers in your eyes?

Rock star economy more like a 1 off economy perpetuated from high immigration flow and now government infrastructure spending. Strip these away and flat GDP for the last decade........get ready for continued economic deterioration with inflationary pressures higher then most expect or anticipate.
NZD /USD =.60

Weaker nzd makes my classic cars worth more , and the stuff I sell more expensive. Theres a win in there somewhere.

I've been looking for a 1953 Bentley, leather interior with a hard top and fitted with a rolls Royce engine if you've got one of those in the collection?

No UK iron, Ive never gotten over owning an Austin once, European and US sourced only...

A weaker dollar will make NZ properties, farms and businesses much cheaper to any foreign investors who can buy them up.