By Roger J Kerr
The Reserve Bank’s sudden downshift in their forecast for economic growth in 2011 has many pundits speculating on what the track of market interest rates will be for the next 12 months.
The current moneymarket pricing of only two 0.25% OCR increases over the course of the next year appears to have taken the RBNZ about-face on the economy far too seriously for my liking. Should the economy grow faster in 2011 than the new RBNZ forecasts, they could well be forced into raising interest rates much faster and in larger jumps in the first half of next year.
Interest rates may well be “lower for longer” in the short-term. However, in the medium-term it does not mean that interest rates will not reach the same point as previously expected by mid-2011.
My view is that 90-day wholesale interest rates will be at 5.00% by mid to late 2011; the debate to take place is just about the path they take to get there. I would have thought that in a patchy and uneven economic recovery, slower and smaller baby-steps would be a preferable strategy than large adjustments later on that potentially scare the horses and sends the Kiwi dollar spiralling up unnecessarily.
Governor Alan Bollard should be thinking about his strategy here, not allowing himself to be dissuaded by the very short-term/changeable outlook of his economics forecasting team. The RBNZ does appear to have knee-jerked in their reaction to recent weaker domestic economic data, rather than looking forward to expected economic conditions in 2011.
The outlook for 2011 remains very positive for +3.5% GDP growth in my opinion as the high export prices increase output, profits and incomes. The RBNZ claim that all the increases in rural incomes will be applied to repay debt and not be spent on consumer goods. Whilst Waikato dairy farmers will be repaying the extra debt they took on in last year’s drought from the spectacular $7 Fonterra milksolids payout, other dairy farmers and export industries will certainly be spending on new assets and investments.
The RBNZ seem to think that the current household caution and de-leveraging will last right through 2011, which is a long-bow to draw on consumer behaviour going forward. I do not see the weaker domestic economic numbers continuing. I see the NZ situation over recent months as very similar to the US economy. The “fools growth” phase from June 2009 to March 2009 which was all about inventory re-building and nothing else, followed by the inevitable lull period in manufacturing output post the inventory re-build.
That lull period is now over as manufacturer’s position for improved end-demand in 2011.
The RBNZ base their muted consumer spending outlook on weaker house prices through 2010 and 2011. It is a worry that the RBNZ yet again appear preoccupied with the residential property market driving all things in the economy. That may have been the case in the 2004 to 2007 period where supposedly the inflation threat came from rising house prices and related rampant consumer spending. The inflation at that time actually came from supply-side factors not demand driven, but that is another story.
The RBNZ run the risk of miss-reading and under-estimating growth and future inflationary risks in the economy and in my humble opinion they will be forced to change their tune on this come March/April 2011.
In the meantime, the June and September 2010 quarter’s GDP numbers will come out below RBNZ forecasts of +0.9% and +0.8% respectively. The June quarter’s numbers are due out this Thursday 23 September are expected to be closer to +0.5% for the quarter. Those results should give them no comfort about their GDP forecasting ability, their 2010 GDP growth forecasts have been well off the mark (RBNZ forecasted +3.5% growth for 2010 and the actual result will be closer to +2.0%). It appears that the RBNZ has been spooked by the recent weaker economic data and as a result this has caused them to lower their 2011 GDP forecasts from +3.5% to +2.6%.
They were wrong on their 2010 forecast (too high) and I see them being wrong again, the other way, (too low) on their 2011 GDP forecast.
What does all this mean for interest rates?
Well, Governor Alan Bollard does not see any problem in the OCR being 2.00% below true market interest rates (5%) now prevailing in NZ. I think he is wrong on that as well. Banks are currently paying 5% for their money and lending out at a margin above that. Monetary policy must lose its potency to change behaviour in the economy if it has to increase by 2.00% before there is any real change to the bank’s borrowing costs, thus lending rates.
One can see the situation developing of Bollard shunting up the OCR in 2011 and it having no impact on the economy as deposit and lending interest rates are already up there.
In summary, the RBNZ U-turn last week on removing the early 2009 monetary stimulus measures runs the risk of monetary conditions being “too loose for too long” in 2010 and 2011, resulting in excessive interest rate and currency volatility later on when they have to correct the policy setting error.
* Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com