Westpac chief economist says the 'market' may be surprised by next week's RBNZ Monetary Policy Statement

The 'market' might be surprised by next week's Reserve Bank Monetary Policy Statement and react by sending wholesale interest rates and the Kiwi dollar higher, according to Westpac chief economist Dominick Stephens.

In a preview of June 12's MPS, Stephens said Westpac economists were expecting a further quarter of a percentage point rise in the Official Cash Rate (to 3.25%) next week on top of the rises in March and April.

They also expected the RBNZ to reiterate its plans to follow up with further OCR hikes this year and next.

"The RBNZ may sound a touch less adamant about the pace and extent of hikes than it was in the March MPS – but only a touch.

"Markets are expecting a more radical downgrade to the RBNZ’s planned hiking cycle, and may be quite surprised by this MPS.

"If we are correct, swap rates and the exchange rate will rise on the day," Stephens said.

"Financial markets seem to be awaiting a much more radical change of tone. We suspect that one of the RBNZ’s key aims next week will be to bring errant financial market pricing back into line with its own thinking – an exercise that can be like herding cats."

Stephens said since April, markets appeared to have become even more sceptical about the extent of the RBNZ’s OCR hiking cycle. ANZ economists have made a similar point in regard to how the markets are pricing interest rate expectations following some recent data indicating the rate of economic growth may be moderating a little.

"Interest rates have fallen to the point where swap market pricing indicates an expectation that the OCR will be 4.0% at the end of 2015," Stephens said.

"By contrast, the RBNZ’s forecasts back in March implied an OCR of 4.5% at that point.

"This drop in market interest rates will be worrying for the Reserve Bank, because it is prompting banks to reduce fixed mortgage rates – the average two-year fixed mortgage rate advertised by the four main banks has fallen 34 basis points in two months," he said.

"Lower mortgage rates could reignite the housing market. What is more, this market-driven drop in interest rates is inconsistent with recent developments."

Stephens said that on balance, New Zealand economic developments since April had tended to support the case for further OCR hikes. In particular:

• The exchange rate has fallen in recent weeks, and on a trade-weighted basis is barely higher than it was at the time the March MPS was published.
• The Government has issued a surprisingly expansionary budget, which will further the need for OCR hikes.
• Net migration has continued to boom, and has exceeded the RBNZ’s expectations by a very wide margin. "We cannot overstate the importance of booming net migration in the RBNZ’s thinking on the housing market and inflation pressures."
• Momentum in the economy has remained strong.

So, Stephens said in the assessment of Westpac economists,  the RBNZ will deliver an OCR hike next week, and will firmly reiterate the case of OCR hikes in the accompanying Monetary Policy Statement.

"The RBNZ’s 90-day interest rate forecast may be a shade lower than the forecast it issued back March – but only a shade."

The "tone" of the June MPS might be "a touch less adamant" about OCR hikes than the tone struck in the March MPS, he said.

"However, the overall tone could be slightly more hawkish than the April OCR Review.

"The challenge for the RBNZ will be to deliver this modest change to the outlook while still prodding errant financial markets into lifting two and three year swap rates.

"The right balance could be achieved by signalling that, from here, the OCR hiking programme will proceed at a pace of 25 basis points per quarter.

"That would allow the RBNZ to skip the July OCR Review while still leaving no doubt about its intention to hike twice more before the year is out. (We expect those hikes to come in September and December).

"If we are correct, next week’s Monetary Policy Statement could produce quite a reaction on financial markets, with swap rates and the exchange rate rising."