This week's review of interest rates by the Reserve Bank is another of those 'get the popcorn ready and be prepared to be entertained' ones.
The market is surprisingly divided about whether the latest Monetary Policy Statement (MPS) to be released by the RBNZ on Wednesday afternoon (13th) will see another cut to the Official Cash Rate (currently standing at 1%) or not.
At the moment a cut is about 65% 'priced in' by the markets. So in other words a non-cut is about 35% priced in. The markets are not sure.
Before the last MPS release in August, the markets were pretty much in unison that there would be a cut. However, in the event the RBNZ blew everybody out of the water by doing a double-cut (50 basis points rather than the universally expected 25 basis points) and so there was a very strong market reaction, with the dollar and wholesale interest rates plummeting.
A changing mood
This time around, it is different. The mood of the market has changed a lot in the last couple of weeks.
Going back to October, the broad expectation was that there would be a cut. However, recent economic data have been benign, while a few comments from the RBNZ to the effect that it's pleased with the reaction to its double cut (taking the OCR from 1.5% to 1%) in August have seen market views changed. Economists are now not so sure. Westpac economists officially changed their view from expecting a cut to not expecting a cut.
What this all means is that whether the RBNZ does cut or does not cut there will be a strong reaction in the marketplace. Of particular interest will be the Kiwi dollar. Speculators are continuing to take the view the dollar will head lower in value. A non-cut would of itself likely put sharp upward pressure on the value of the dollar and that would likely increase as speculators may feel forced to 'unwind' the positions they've taken.
A key factor in the RBNZ deciding whether to cut or not to cut comes from a piece of information that's not widely followed by the general public. This is the quarterly Survey of Expectations the bank commissions. Within this survey the crucial element is what businesses think inflation will be doing in one year and, more importantly two year's time.
The last survey results came out just before the August MPS and showed a sharp drop in inflation expectations. That was probably enough to tip the RBNZ over the edge in deciding to go for the big blunderbuss double-cut.
The RBNZ will already know the results of the latest survey, with these due to be released publicly on Tuesday (12th).
The survey may decide
I think you could say with some certainty right now that if the results show a further drop in inflation expectations then definitely lock in a cut for Wednesday. If the expectations show little change, or perhaps a rise in inflation expectations, then there's a much better chance that the RBNZ will hold fire.
The other interesting thing to bear in mind from this week's review, however, is that it is the last for the year - with the next one not till February 12. That's a long time between drinks. Or more to the point, a long time for the RBNZ to sit on its hands.
The NZ Institute of Economic Research has for some time been convening a 'Shadow Board' of experts offering views on whether they think the RBNZ should cut rates or not. The views within this board have been getting broader and broader within recent months, and that's been heightened by the latest release from the 'board' this week.
Motu academic Arthur Grimes - a former RBNZ chairman - has been casting doubt on the wisdom of further cuts for a while now and has suggested that the OCR should actually be higher. In the latest release he says that after the 50bp cut in August, there is no need to cut further – "especially as the previous cut had the effect of reducing economic confidence".
What about a partial reversal?
"A partial reversal of the previous cut is warranted, but it is probably best to let the dust settle for a while."
Fellow academic and 'board' member Viv Hall of Wellington's Victoria University said there's insufficient evidence to justify a further OCR cut.
"Some early evidence [is visible] of re-emerging house price inflation, and of non-tradeables inflation resuming its modest upwards trend," he said.
"On balance, no change recommended to the OCR, together with a minor bias towards an OCR increase sometime in the future."
However, the diversity of opinion within the NZIER's shadow board is demonstrated by Kiwibank senior economist and 'board' member Jeremy Couchman, who said the right course of action for the RBNZ is tilted in favour of a 25bp OCR cut.
"The global economic outlook has deteriorated, business confidence surveys report weaker business activity ahead (despite 75bps of cuts already delivered in 2019), and inflation expectations eased further below the RBNZ’s 2% target mid-point. For the Bank it comes down to what move is likely to deliver the path of least regret."
And of course the diversity of opinion extends out to what the major bank economists have been saying in their previews of the OCR decision.
Here's some key points I've selected from what the economists have been saying:
BNZ senior economist Craig Ebert:
Pulling everything together then, the OCR committee will probably feel the case for another rate cut is finely balanced – in the least not obvious. After much toing and froing, however, it will probably err on the side of a 25 basis point cut, we believe. This is even though we think there is no overwhelming basis for it, at this juncture.
But we can’t leave our discussion at that. We need also think about where NZ monetary policy might be going over the broader sweep. Pause or no pause next week, the RBNZ will still feel its policy is keyed off its GDP growth forecasts. With this, and its inherent vulnerabilities, we might wonder…what will stop the OCR ultimately going to zero (even negative)?
We can’t help but think it will have to be signs that inflation (pressure) is more robust than the Bank judges. This is unlikely to be obvious via headline GDP growth, which looks set to appear a bit underwhelming. So it will likely have to involve more direct signs that inflation is simmering, even heating up, in turn causing reassessments of output gaps, the NAIRU, and the like.
We would argue that such indications are already appearing, in the likes of; the latest labour market data; non-tradables inflation; the strong cost inflation that is pressuring the business sector, even the renewed broadening in house price inflation. But it will probably take more time for this to become obvious, especially in the eyes of the RBNZ. And, of course, if the economy genuinely loses a lot of steam, complete capitulation in the OCR would seem the likely end-game, in that scenario.
Westpac chief economist Dominick Stephens:
...Our analysis suggests that the RBNZ’s OCR forecast will be unchanged relative to August, bottoming out at 0.9%. Consequently, we expect that the RBNZ can stick to its previous course and keep the OCR on hold, while acknowledging that the risks are skewed towards lower rates.
Our view is that evidence favouring a cut will have accumulated sufficiently by February, which is when we think the OCR will reach its low of 0.75%. That is based on our view that global economic sentiment is going to deteriorate once again.
ASB senior economist Mark Smith:
Our conviction is that the RBNZ should (and likely will) cut the OCR by 25bps in November.
The short-term growth outlook is sub-par and risks are skewed to the downside, with the RBNZ needing to take out more insurance to prevent a more protracted undershoot of its employment and inflation objectives.
We expect the RBNZ to hold out the prospect of further policy stimulus, if needed. To us, 0.75% is unlikely to be the OCR floor and a move lower in 2020 beckons.
ANZ chief economist Sharon Zollner (who is picking an OCR cut on Wednesday):
...Looking ahead, we predict that the OCR has not seen its lows. The global outlook remains shaky, businesses are wary, and changing bank capital requirements will tighten financial conditions, requiring a lower OCR to offset. We won’t know the details of the latter until early December, but it will presumably enter the RBNZ forecasts at the February MPS. We have put in a 25bp cut in May as a placeholder for now. This would take the OCR to 0.25% – around where we consider its useful limit to be. Any further downside surprises will therefore up the ante on both fiscal policy and unconventional monetary policy options.
We expect that the RBNZ will leave the door ajar to an OCR below 0.75%, with the forecast rate track bottoming out slightly below that. The RBNZ will likely prefer to avoid a clear “one and done” rate-cut scenario, as this would risk prompting an unhelpfully hawkish market reaction and a tightening in financial conditions. That said, with market pricing having come back considerably recently, the RBNZ may now be less concerned about this possibility.
The likely market response in both rates and FX will be a part of the RBNZ’s ‘regrets’ analysis, which has featured prominently in the rate cut decisions and discussions of late. ‘If you don’t have much ammo, come out firing’ has been the approach thus far, and we are assuming they’ll stick to the general principle of it being better to risk overdoing it than miss the boat. It’s a long time until the next rate-cut opportunity in February.
Kiwibank chief economist Jarrod Kerr and senior economist Jeremy Couchman:
We don't believe it's time for the RBNZ to sit on its hands. This week, the RBNZ has the opportunity to 'surprise' markets, again, with a 25bp (not 50bp) cut to an [Australian] RBA-equalling 0.75%. The element of surprise is important. Sentiment in financial markets (or risk appetite) has improved markedly. Global equity markets have been buoyed by mentions of a trade deal (phase I) between the US and China, a postponement of Brexit (and election), and continued central bank support. Thoughts of recession have receded, but remain.
The sharp improvement in sentiment largely reflects re-positioning, and the amount of pessimism previously priced. The fundamental economic picture, however, is little changed. Economic growth is sub-par, and inflation is hard to find. Sentiment in markets has gone from too pessimistic, to arguably a little too optimistic in a matter of weeks. The economic reality is somewhere in-between. New Zealand's economic reality is warm, far from hot, and cooling. Goldilocks would cut rates, given her bearish surroundings.
If the RBNZ keeps the OCR unchanged on Wednesday, we can expect to see higher lending rates by the end of the week. Wholesale rates have already risen with the rise in global risk appetite - see our chart of the week - and will be passed on to lenders with another pop higher (on an RBNZ pause). The Kiwi currency would also lift with the relative rise in Kiwi interest rates, impacting the export sector. That's fine and good if we truly believe the worst is behind us. But not believe that.
So, take from all that what you will. As far as yours truly is concerned, I'm picking a 25 basis points cut, largely because the RBNZ has so long to wait before its next scheduled review and a cut now will keep it ahead of the game.
But then again, I nearly fell off my chair in surprise at the outcome from the August OCR review, so, it's fair to say I'm expecting anything. It won't be dull.