Westpac economists stick to view that RBNZ will be forced to drop interest rates by more than it currently intends

Westpac economists stick to view that RBNZ will be forced to drop interest rates by more than it currently intends

Westpac economists are sticking to their view that the Reserve Bank will be forced to drop interest rates by more than currently intended.

The Westpac economists are still adamant that an Official Cash Rate of 2% will be needed - though in their latest weekly commentary they have slightly shifted the predicted timing of the move.

And ASB's economists acknowledge the RBNZ as "reluctant cutters" of interest rates. "...But we still see weak inflation pressures ahead, and the higher NZD is not going to help," ASB senior economist Jane Turner said. 

"We now grudgingly accept the RBNZ will not cut the OCR in October.  But we still believe the weak inflation outlook does warrant lower interest rates now, and expect the stubbornly-high NZD may force the RBNZ’s hand come December."

Turner said "rather worryingly", the RBNZ is still holding out hope that "Princess Charming" - in the form of Janet Yellen from the US Federal Reserve will "come to rescue it from its tricky situation".

"The RBNZ still believes that Fed hikes will lift the [US dollar].  And some eventual USD strength is probable.  But the odds are the Fed delays its rate hikes and even scales back its forecast for how much it could lift interest rates.  The USD will struggle to get much lift in this situation. And the focus on the Federal Reserve influence overlooks the fact that the [NZ dollar] is up against most of its key exchange rates.  Only a return of offshore market jitters, RBNZ rate cuts or declines in commodity prices can reverse the broader NZD rebound.  The latter influence isn’t likely to happen either.  Dairy prices have bounced off lows and reports of low dairy collections will only reinforce the dairy markets conviction of a sharp fall in NZ production this year."

The Westpac economists say they have "long disputed" the RBNZ’s view that a lower exchange rate would return inflation to 2% on a sustained basis.

"Consequently, we have argued that only one further OCR cut will not be enough. Instead, we have been forecasting further OCR reductions, in January and March of next year, that would see the OCR fall to 2.0%.

"We remain steadfast in our view that the terminal OCR will be 2.0%. In fact, preliminary work indicates that inflation in 2016 could be even lower than we are currently forecasting – not least because the exchange rate has shot up recently."

But the economists said that after a "Hawkish" speech by RBNZ Governor Graeme Wheeler last week, and with dairy prices and the housing market so strong, they had been forced to rethink the timing of OCR reductions in 2016. "We are now forecasting OCR reductions in March and June next year."

They said their forecast assumes three key developments will have taken place by March: (1) An El Nino drought will have impacted agricultural production; (2) The housing market will have slowed as a consequence of mortgage lending restrictions in Auckland; and (3) Data will have made it clear that inflation is set to run closer to 1% than 2% for much of 2016.

The economists said the strong housing market was clearly worrying the Reserve Bank.

"...Governor Wheeler reinstated housing as an issue of direct concern for monetary policy, mentioning the risk of low interest rates inflaming the housing market. That’s quite a turnaround – the RBNZ downplayed the housing market when it decided to cut the OCR in June, to our surprise at the time. And the September Monetary Policy Statement pointedly omitted any forecast of house prices."

The economists said while Wheeler's speech confirmed that the RBNZ still intends to reduce the OCR below the current level of 2.75%, other comments "were hawkish".

"In addition to the housing market, the Governor referred to encouraging local economic data, and to the virtue of correcting deviations from the inflation target only slowly. And he eschewed reference to the renewed vigour of the exchange rate."

As result of these comments, the Westpac economists said they remained "very comfortable" with their forecast that the RBNZ would make no change in the OCR at the October Review next week and they concluded that the RBNZ was still just planning one further OCR hike in the current cycle, most likely in December.

Looking at the housing market, the economists said some of the shift in regional focus is due to Aucklanders buying houses in cheaper centres nearby.

"...But Reserve Bank and Government policy is also playing a role. For most regions of the country, lower interest rates and the upcoming loosening of mortgage lending restrictions is a stimulatory cocktail for house prices. Meanwhile, mortgage lending restrictions are about to be tightened for Auckland. And new tax rules targeting property 'flippers' are more of a negative for Auckland than other markets, due to the preponderance of speculators in Auckland."

ASB's Turner said one reason the RBNZ is reluctant to rush further cuts is that it wants to keep its powder dry in case the global outlook deteriorates markedly over the coming year. 

"This is a fair call given the growing risks to the global outlook. During the Global Financial Crisis the RBNZ was very mindful that at some point OCR cuts could become ineffective. In theory the RBNZ can cut all the way to zero. In practice, given NZ’s risk premium vs the rest of the world, OCR cuts could at some point lose potency in influencing other market rates.  Indeed, the US Federal Reserve ran into similar problems and had to resort to risky and untested methods to make monetary policy work more effectively."

Turner said the third-quarter inflation outcome, while weak, may not be enough of a red flag to convince the RBNZ that lower rates are needed now.  

"However, we are more dovish than the RBNZ and we are not convinced inflation will pick up meaningfully in the next two years. There are some troubling details in the inflation report and recent business confidence surveys.  Also the recent rally in the NZD also threatens to undermine the RBNZ’s assumption that tradable inflation (largely imported retail items) is about to lift sharply. The recent NZD bounce gives a new window of opportunity for importers to lock in some hedging for those that missed out - there are quite a few relieved importers out there at the moment.

"The NZD is tricky for the RBNZ. A more dovish outlook would help take some of the air out of the NZD.  However, as mentioned above, the RBNZ does not want to shift its stance yet, in case the global economy deteriorates."

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.

21 Comments

Comment Filter

Highlight new comments in the last hr(s).

Wow , this raises more questions than answers

Is this purely about the currency or is it something else ?

Why is a monetary stimulus needed ?

Are we heading for a slowdown ?

Or are we in the start of a deflationary spiral ?

Stimulus is needed because inflation is negligible.

Yes we are headed for a severe Great Depression sized slow down

Deflationary spiral, see sentence above. Except we have never been in a situation of a permanent shrinking economy lasting several decades so who really knows.

Stimulus is needed because inflation is negligible.

Did I not see your claim to be an engineer for 35 years? If so, supply the working examples of that which you propose. Conjecture is for the social sciences such as economics.

Careful what you wish for.

U.S. banks are going to new lengths to ward off a surprising threat to their financial health: big cash deposits.

State Street Corp. , the Boston bank that manages assets for institutional investors, for the first time has begun charging some customers for large dollar deposits, people familiar with the matter said. J.P. Morgan Chase & Co., the nation’s largest bank by assets, has cut unwanted deposits by more than $150 billion this year, in part by charging fees.

The developments underscore a deepening conflict over cash. Many businesses have large sums on hand and opportunities to profitably invest it appear scarce. But banks don’t want certain kinds of cash either, judging it costly to keep, and some are imposing fees after jawboning customers to move it.

The banks’ actions are driven by profit-crunching low interest rates and regulations adopted since the financial crisis to gird banks against funding disruptions. Read more

Charging for any cash deposits is a by the book measure for implementing effective negative interest rates. If banks are doing this it's a major warning sign that the US is a long way from recovery.

Perhaps it's time the Fed started mopping up all that worthless cash.

.

if this is too come true NZ will be in worse shape than the GFC

This is all very disappointing , saving money is practically useless in this climate .......... just when I have got to the stage of my life when my income far exceeds my expenses by over half each month ( I have no debt whatsoever and my home is paid for ) then this mess comes along .

I have saved , scrimped and been careful with money since I got my first piggy bank almost 6 decades , and now the contents are worth nothing as savings .

Welcome to the club. Been 0.5% interest rates in the UK here for 8 years now. Saving is indeed fairly pointless.

but....but....capitalism is great!!
.
Isn't it?

So for 60 years your generation and the one before have exploited the planet in order to put $s in the bank so you can buy things later with the "interest". isnt working is it? like I have been saying for several years now and this hasnt even started yet. just wait until we start to get real pain and OBR events where there will be a call on "your" money, or default on it.

Its not a mess mate, I have also paid off the mortgage so I quit working and started to enjoy life. Your way older than me so time to stop saving anyway and just start enjoying life, whats the point in saving when your 60 plus ? waste of time you could drop dead tomorrow, time to start enjoying your life and spending your hard earned money.

I predicted another rate cut before the end of the year and another early next year, great for those with a mortgage and who made the commitment to buy instead of whinging about the price of houses.

Stick it to the savers - pal - maaate - mongrel - a***holes

savers or saved?

So you are on a finite planet and have peaked extraction yet expect interest which is a future increase in extraction, which simply cannot happen.

congrats.

With the current orthodox, if in my view sub optimal, monetary policies in action around the world, you really have to agree with Westpac. Wheeler's out of nowhere speech last week appears to have driven the NZD higher, such that whatever tradable inflation he thought just might turn up due to exchange rate devaluation has surely now disappeared well over the horizon. And there's no other kind of inflation around, other than asset bubbles.
Any Fed lift in rates could be a change in circumstances he could respond to, but he seems to be trying to preempt what he thinks they should do, and not what they have been or are likely to do.

If I have $100 in my pocket and petrol costs $1 more,

a) where does the $101 come from?
or
b) what dont I buy,
or
c) what has to get cheaper from me to be able to afford to buy?

how is the effect of an overhead that cannot then be past on be inflationary?

Am not sure what point you are making, or how it relates to my point. Nevertheless the Dept of Stats run the inflation numbers, and currently have the basket of goods and services based on average household spending running at +0.4% per annum, vs the RB target of 2%, or at least 1-3%.
Petrol prices in NZ are shown here:
http://www.interest.co.nz/charts/commodities/oil-and-petrol
Petrol is 7% cheaper than this time last year, although its true that it is 16% dearer than its trough in January, and 5% higher than its end quarter trough. (The Reserve Bank I think looks at end quarter numbers).
Assuming the Stats basket is reasonably representative, then it seems that the prices of typical household expenditure has changed very little in aggregate for some years, and there's little to see that changing, even if petrol goes up 20cents a litre (and there's nothing obvious to see that happening either).
Separately people are in total relatively flexible in changing discretionary purchases from say overseas holidays to domestic leisure, or vice versa, if the exchange rate moves to encourage them either way. So they will change their basket, either for price or lifestyle reasons, and Stats does amend the basket over time to reflect that.
The major cost or income not reflected, is interest, either earned or paid.

The point I am making is ppl have no more money in their pockets hence why we have 0.4% inflation overall. " typical household expenditure has changed very little in aggregate for some years" exactly, no more $ in ppls wallets means you cannot get inflation in everything/overall.

So if CPI goes up or some items in that or items outside of that, eg comms, have to decrease or there is no sale.
" relatively flexible in changing discretionary purchases" that is just my point. There are too many ppl wiht little cash that they can class as discretionary. If they do have some then when CPI goes up there is less discretionary options.

Comms is probably a good one, my costs are down 25% for broadband and mobile.

"exchange rate" indeed some of the offshore items I want to purchase are up 20% in NZ or shipping in after paying in US is now a lot more marginal, result I am spending less/more slowly, though I am watching some items drop significantly in US price suggesting over-supply/lack of demand, sadly compounding this the State Department fees are now significant.