By Dominick Stephens
In ordinary circumstances, our preview of next Thursday’s Official Cash Rate (OCR) review would have been an incredibly bland affair.
At the September Monetary Policy Statement the Reserve Bank issued a “firmly on hold” outlook for the OCR. In coming to that view, the central bank contemplated a weak global economic environment, modest GDP improvement in New Zealand, fiscal austerity, rising house prices, the Canterbury rebuild, low inflation, and the excessively high New Zealand dollar.
The economic landscape has changed very little since that time. True, inflation data was slightly weaker than expected, but GDP data was slightly stronger. The recent round of fixed mortgage rate reductions will act like monetary stimulus. But that is probably welcome, given that there have been signs of slightly slower economic growth over the September quarter.
The exchange rate is still high, but no more so than the RBNZ anticipated. And global markets are arguably calmer than they were six weeks ago. In ordinary circumstances we would have said that things are evolving broadly along the lines the RBNZ anticipated, so there is no need to change the “on hold” stance for the OCR. End of story.
New Governor seen as more dovish
But these are not ordinary circumstances. The Reserve Bank has a new Governor (with Graeme Wheeler replacing Alan Bollard), and he may interpret the current economic situation differently to his predecessor. Financial markets appear to have taken the view that the new Governor will be more “dovish”. Interest rate markets are increasingly pricing in the possibility that the OCR will be reduced within a few months.
Experience certainly suggests that the person at the top matters for monetary policy. The Reserve Bank rapidly changed tack from OCR hikes to OCR cuts soon after the last change of Governor, surprising markets in the process.
The big unknown is how the new Governor’s attitude will differ from his predecessor’s. Our views are no more or less valid than anybody else’s. But for what it is worth, our thinking is that the incoming Governor will start his term calmly and cautiously. The Reserve Bank’s target is to keep future inflation close to 2%, on average over the medium-term.
Wheeler will be presented with a staff inflation forecast that averages bang on 2% from one to three years in the future, which is the usual target horizon. The most prudent course of action would be to keep the OCR on hold and issue a statement that is ambivalent about future OCR changes. This could be achieved by repeating the last sentence of the September statement: “It remains appropriate for the OCR to be held at 2.5 percent.”
If market speculation is closer to the mark, and the new Governor decides that lower interest rates are appropriate, then the October OCR review would probably be used as a signalling opportunity. On the day, the OCR would probably be left at 2.5%. But strong hints of future OCR reductions would be given in the accompanying press release.
Market implications
Markets are nervous about this OCR review. A reaction of some sort seems highly likely. Current market pricing suggests a better than 50% chance that the OCR will be cut by January. If the Reserve Bank validates that thinking in any way by hinting at OCR reductions, interest rates could fall sharply on the day.
By contrast, if our tentative thinking proves correct and the RBNZ issues a bland OCR review, interest rates would probably rise only slightly.
*Dominick Stephens is Westpac's chief economist.
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