By Ian Robertson*
From the outset the new Reserve Bank of New Zealand (“RBNZ”) Governor has demonstrated a more forthright approach to his communication of monetary policy. Relative to many of his global central bank peers this governor leaves much less to suggestion.
This was demonstrated in the August 2018 Monetary Policy Statement. While the Official Cash Rate (“OCR”) was kept on hold at 1.75%, the first line of their press release specifically stated that the RBNZ now expects “to keep the OCR at this level through 2019 and into 2020”. Previously its central forecast indicated a move higher in late 2019.
The RBNZ also reiterated previous guidance that the next move in its OCR could be up or down. To illustrate, it provided a simple scenario analysis for two possible tracks for the OCR:
- A 0.50% increase to 2.25% by 2021 if inflation is higher than expected
- A 1.00% cut to 0.75% if annual GDP remained below 3.00%
All this points to a dovish tendency, i.e. a willingness to keep rates lower, highlighting its willingness to support the economy. This may reflect its broadened mandate (discussed here) which now includes supporting maximum sustainable employment in addition to targeting Consumer Price Inflation (CPI) inflation.
In aggregate, the incrementally dovish move appears to reflect increasing concern at the RBNZ for the economic outlook. It is likely that was underpinned by falling business confidence, and other factors including wariness with respect to housing and the timing of government spending.
The change in RBNZ tone was considerably more aggressive than interest rate and currency markets had been expecting. In response the market lowered its expectation of future interest rates (now pricing a possibility of OCR cuts) and the NZ dollar weakened.
The below chart shows the RBNZ’s August 2018 forecast for an increasing OCR towards 2.00% in late 2020 is now roughly a year later than the RBNZ was forecasting in its May 2018 statement:
Source: August 2018 Monetary Policy Statement
What does this mean?
The OCR is just one of myriad factors influencing bond yields and bank mortgage/deposit interest rates, some of which we have discussed (here). Nevertheless, in simple terms:
- For borrowers, floating and short term fixed interest rates will likely remain lower for longer. It would not come as a surprise if banks contemplate reducing some fixed mortgage rates. After a slew of headwinds facing housing prices this may provide a modicum of relief.
- For bond investors, the prospect of new NZ bond issuance at higher interest rates looks to be some way off. The same can be said for term deposits. The flat OCR outlook should, however, support the prices of existing bonds in the secondary market. An important caveat is that longer dated NZ interest rates are also influenced by events offshore. There remains a risk offshore yields increase further into next year which should put upward pressure on NZ’s longer dated interest rates.
- For NZ shares, the development should provide some support through a) monetary policy underpinning the economy, and b) benefiting income shares which provide a large portion of the NZ share market.
As described in Milford’s bond fund Monthly Review commentaries, although we have recently extended our interest rate exposure, we continue to limit the absolute level of our exposure, mindful of this upward pressure.
*Ian Robertson is a senior analyst at Milford Asset Management. This article first appeared here and is used with permission.