The Reserve Bank’s harshest critics have shifted their view on when the Official Cash Rate will need to be hiked, back slightly towards the central bank’s own projection.
BNZ economists said they were now pencilling in “with some trepidation” the next hike in mid-2018, compared to an earlier expectation of Q1 2018. The Reserve Bank itself isn’t forecasting a rise in the OCR until September 2019 at the earliest. Market pricing is also for mid-2018.
Despite the shift, BNZ economists said there remains huge uncertainty about the next move, and they were still not ruling out a February 2018 rate hike. However, a May or August hike appeared a better reflection of the situation – partly because the Bank would be issuing Monetary Policy Statements in these months, giving a new RBNZ Governor the ability to explain his or her reasoning better than in a pure OCR statement, like in June.
The BNZ’s Head of Research, Stephen Toplis, has been the RBNZ’s number one critic in recent years, with Reserve Bank Governor Graeme Wheeler even resorting to the extraordinary step of complaining to BNZ CEO Anthony Healy about the tone of Toplis’ commentary earlier this year.
In the BNZ’s latest Strategist publication Thursday evening, Toplis sought to keep the heat on the Bank, albeit with perhaps a slightly less aggressive tone. A lot of the reasoning behind the shift was down to how BNZ’s economists expect the RBNZ’s game plan will evolve.
“Given that the Bank’s current forecasts have no increase in rates until late 2019/early 2020, it would be difficult to justify a hike in rates any time soon without first acknowledging that the time for doing so was no longer so distant,” Toplis said.
“As such, we think the first action of the central bank would be to go to a tightening bias, the second to formally bring forward any prospective tightening and then, finally, actually pull the trigger. Given that the Reserve Bank doesn’t seem to like shifting its stance at OCR reviews, this process would need to evolve over three consecutive Monetary Policy Statements.
“If we are right, this would mean, at the earliest, an August 2017 move to a tightening bias, November bring forward the projected tightening and then February 2018 raise rates.”
But it might take slightly longer than that to play out. Toplis argued the Bank’s May MPS revealed no intent whatsoever to position it to move to a tightening stance in August, keeping its ‘neutral’ tone. “As hard to believe as this may be, it is the Bank’s stated view so can’t be ignored,” he said.
Could reasonably be talking rate cuts, but inflation pressures remain
Meanwhile, economic developments since the May MPS were more likely to convince the Bank it was doing the right thing. Q1 GDP was weaker than expected, although BNZ was expecting a pick up in Q2 to cover the shortfall. Inflation indicators – particularly driven by the oil price – had taken a turn to the low side, he said.
BNZ economists themselves had slashed their CPI inflation expectations for the near term to 0.1% in Q2 and 0.2% in Q3. “This now leaves our year to March 2018 annual CPI forecast sitting at just 1.2%.” On top of this, the TWI exchange rate tracker has remained higher than the RBNZ had been picking, which itself would shave 0.5% of its year-ahead CPI forecasts.
“Indeed, at face value, [the developments] would demand rate cuts,” Toplis admitted. Add in that banks themselves have been increasing mortgage rates without the OCR moving, bank lending constraints and a softening housing market, “one might reasonably ask why, under these conditions, we are even talking about rate increases at all.”
He gave his reasoning: Food prices remained stubbornly high, core inflation looked set to sit above headline inflation, inflation expectations would remain at or above the 2% mid-point, fiscal policy would be stimulatory, commodity prices had risen, capacity utilisation was high and the labour market continued to tighten.
What’s more, central banks around the world were shifting to tightening stances, including the US Fed, Bank of England, European Central Bank and the Bank of Canada. “If these respective central banks do start moving in the manner implied it will make it easier for the RBNZ to do likewise,” Toplis said.
“Importantly, Governor Wheeler seems to have been heavily influenced by the actions and rhetoric of the key central banks in the past. Indeed, it is this, more than anything that has created our trepidation in pushing back our expectations of the RBNZ’s expected rate track, particularly given that we believe both inflation and capacity pressures are greater in New Zealand than in Canada,” he said.
On top of all that, Toplis maintained that interest rate settings in New Zealand appeared more consistent with an economy that was under stress, rather than one growing steadily.
Eye on election, next governor
Meanwhile, with one eye on the 23 September election, and the other on the Reserve Bank’s upcoming Governorship change, Toplis argued that “forecasting the actions of the RBNZ over the next twelve months is even more fraught with danger than normal.” Graeme Wheeler will step aside in September, and interim Governor Spencer in March 2018.
“Even if the Bank’s mandate remains unchanged, we know from both past New Zealand experience and what’s happened offshore that the culture of the central bank can change and even its interpretation of the “rules” can do likewise,” Toplis said.
“At the extreme, a new Governor may even choose, with the support of the Finance Minister to adjust the Policy Targets Agreement. There is certainly significant precedence for this. And, last but not least, we do have a General Election which could conceivably deliver a new Minister of Finance with a very different view of how the RBNZ should operate.
“Our view on where the rate hike cycle begins is not that different to the market’s with June 2018 currently priced in for the first move. June, of course, is unlikely as it’s an OCR review date not an MPS. The market then has a second rate hike by November 2018 with the potential for a couple more the following year.
“We still think that, ultimately, the cash rate will need to push up to and through neutral and that when the process begins it will tend to be quicker than the market will price. We do not know exactly where neutral is these days but we do think it is substantially higher than where rates currently are. We have, for now, lopped the top off the peak in our OCR track to 3.0% from 3.75% to acknowledge the widening spread between the cash rate and lending rates but acknowledge that this spread has changed significantly in the past and can do so again.”