Local data was thin on the ground again last week, leaving markets to attempt to draw some meaning from the RBNZ’s quarterly survey of expectations.

The survey seemed to take on even greater significance after Governor  ollard’s speech the previous week, emphasising  the importance of keeping inflation expectations in check as the economy recovers, and at a time when government  policies are expected to push annual inflation towards 5% next year. While the speech itself would have been written well in  advance, the decision to put it on the public record appeared to be on short notice – fuelling speculation that the RBNZ had seen the survey results, and was trying to downplay a surge in inflation expectations before it was published.

That proved not to be the case. Average expectations for two years head,  the measure that best corresponds to the RBNZ’s medium-term horizon for  olicy, fell from 2.8% to 2.6%. That is still fairly elevated – in the  top quarter of the 1-3% target band – but is in line with the RBNZ’s  most recent projections. The increase in GST to 15% was confirmed since the last survey, but respondents seem to have decided that the ediumterm effects on inflation, if any, were outweighed by the softening in the economic outlook.

These results will give the RBNZ some comfort that inflation expectations should remain anchored during the spike in headline  inflation over the next year or so. However, since the RBNZ has already downplayed the role of expectations to focus on actual wage- and price-setting behaviour, it’s unlikely we’ll get the final word on this issue until the inflation spike actually occurs.

Financial markets have continued to scale back the odds of further OCR hikes, with only a one in four chance of a hike  factored in for the September Monetary Policy Statement, and just 50 basis points of tightening expected over the next  year. As we’ve said before, the RBNZ still appears to have every intention of returning the cash rate to neutral levels –  somewhere in the order of 5-6% – over the medium term. However, short-term tactics are another matter, and not one  that the RBNZ has done much to articulate. Our view is that on balance – and it is a fine balance – a hike in September would be more consistent with the RBNZ’s recent comments than would a pause, but you can pick out statements that support either case.

One factor playing on markets is the ‘Jackson Hole meeting’ – the annual monetary policy symposium hosted by the  Kansas City Fed on August 26-28. Dr Bollard is a regular attendee, along with a host of central bankers, academics, and a few market economists and journalists.

On the face of it, there would seem to be reason to worry about what kind ofmessage the Governor will take away. The  usual mix of attendees means thatthe discussion is likely to have beenskewed towards the US and to a lesser degree  Europe, rather than the booming Asian and Australian economies that make up a large and growing share of New  Zealand’s export markets. But it’s a stretch to presume that Dr Bollard will be privy to secret information about the state  of the world, which would drive his OCR decision in September. It’s certainly plausible that in August 2008 he was alerted to how close the US investment banks were to collapse, which prompted the 50bp rate cut in the September  MPS. (Lehmans collapsed a few days later.) But in other years, there’s been no sense that September decisions were overtly influenced by international concerns.

The data calendar perks up this week. Today’s trade balance for July slipped into deficit as expected, with export volumes nearing a seasonal low point, though prices remain firm. Imports rose by more than we expected, led by plantand machinery, which is an encouragingsign for business investment. Consumer goods imports were also stronger,  hich may be an indication of retailers stocking up to meet a pre-GST spending rush.

Business confidence (Mon) has fallen in the last two months, although it has remained at historically elevated  levels as firms have kept the faith in the recovery story. Recent sectoral indicators have been mixed, but we could see a further  pullback in confidence, to levels more consistent with the actual growth performance to date.

The upward trend in residential building consents (Tues) has slowed  dramatically since the start of this year. We still  think that consents will need to pick up the pace to meet growth in demand for housing over this year; the rebound
in net migration in July has alleviated some of the downside risk to that view. However, another undershoot would almost certainly see us revise down our forecasts for residential investment for later this year and early into 2011.

Finally, Fonterra’s online auction (Wed) will provide more insight into whether this season’s dairy payout forecast can be  maintained. We expect prices to be up slightly compared to last month.

Fixed vs. floating:
The gap between fixed and floating rates has narrowed significantly – partly because financial markets are questioning  the RBNZ’s resolve to return the OCR to normal levels. Borrowers who believe that the economy is simply wobbling  along the path to recovery, and therefore that the RBNZ will continue to normalise the OCR in the next few years, will find  today’s 2-3 year fixed rates very attractive. Those who believe that markets are presaging a return to recession will be  more attracted to floating rates.

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Westpac Weekly Commentary 16 August 2010 >>
Westpac Weekly Commentary 09 August 2010 >>
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Westpac Weekly Commentary 19 July 2010 >>
Westpac Weekly Commentary 12 July 2010 >>