The RBNZ raised the OCR to 3.00% as expected, but hinted at a more moderate path for interest rates over the next few years. The statement that caught the most attention was: “The pace and extent of further OCR increases is likely to be more moderate than was projected in the June Statement”.
Projecting a slower pace of tightening, relative to the front-loaded profile that featured in the June MPS, seems an appropriate response at a time when the most recent data has raised questions about the pace of recovery, both here and overseas.
However, a more moderate “extent” suggests that the RBNZ has also lowered its expected end-point for the tightening
cycle a couple of years down the track. We won’t know whether there’s been a meaningful change until the next set of
forecasts are published in the September MPS. But that’s a stronger reaction than we would have expected to a handful of data over a short time frame.
Even with the prospect of a lower track for interest rates over the next couple of years, there was no indication that
the RBNZ is ready to heed the calls by some for a pause in the tightening cycle. The statement was fairly explicit about the RBNZ’s motivation for moving the cash rate to less stimulatory levels. Annual inflation has been around the middle
of the 1–3% target band for the last five quarters, in the wake of a protracted downturn. As the economy expands, the
pressures on inflation will only grow from here. Unlike the June statement, there was no reassurance from the RBNZ that even underlying inflation will remain contained within the target.
The matter is further complicated by a range of government policy-related price hikes that will push annual inflation to
around 5% by the middle of next year. The RBNZ is assuming these won’t have any lingering effects on inflation, but
the risks to this assumption are all one way (inflation expectations may or may not rise as a result of these policies;
they certainly won’t go down). The RBNZ sounds increasingly concerned about this: “the price and wage setting behaviour of firms and households will be monitored for evidence of any increase in inflation expectations”.
Our view remains that the RBNZ will continue to work its way towards a peak in the OCR of 6% by early 2012. There
may be some pauses along the way – but equally there could be some larger hikes, depending on the information to hand at the time. For us, last week’s statement actually strengthens the odds of further hikes this year – or at least makes them less data-dependent – since the RBNZ would clearly prefer to have the OCR at a less stimulatory level.
Last week’s data releases simply reinforced the two-speed nature of the recovery.
Business confidence is now clearly off the peaks reached in the first half of this year, though it would be a stretch to say that businesses are feeling gloomy – the general level of own-activity expectations is still consistent with a solid pace of growth. Export-oriented sectors are in reasonable shape, while the property sector has been buffeted by some clearly negative tax changes. Housing consents rose by less than we expected, and it is now clear that residential investment will be weaker than we forecast later this ear and early into 2011.
Even with the slowing in net migration inflows, the current pace of housing construction will not be enough to meet demand, perpetuating the squeeze in the housing market that we have identified for a while. On the plus side, the June merchandise trade surplus was better than we expected.
Exports have been less affected by drought than we anticipated – the volume of milk powder exports was actually well ahead of last year. Imports are picking up gradually, but demand for consumer goods is still subdued. The annual trade surplus amounts to 1.6% of exports, compared to an average deficit of 15% of exports over the preceding five years. Times are changing.
Fixed vs. Floating
The decision to fix or float remains finely balanced. Floating rates remain lower than short-term fixed rates at the moment, but they are likely to rise faster as the RBNZ increases the OCR. Fixing, if even for a short term, has the dvantage of greater certainty around cash flows, at a time when floating rates could be rising rapidly.
Repaying more than the minimum amount, and spreading the loan over a mix of terms, can also help to reduce the overall risk around uncertain future interest rate changes. Indeed, the statement gave the sense that the RBNZ would be uncomfortable with pausing while the OCR is still at abnormally low levels. Right from the outset the Governor said that “it is still appropriate to continue to reduce the extraordinary level of support implemented during the 2008/09 recession”, later noting that “even after today’s move, the level of the OCR is still very supportive of economic activity.” Compared to the fairly bland statement in June that “the further removal of stimulus will be reviewed in light of economic and financial market developments”, that’s a fairly strong signal that the RBNZ intends to forge ahead with more hikes over the next few reviews.
While the data over the last seven weeks have clearly been soft on balance, the risks around the RBNZ’s forecasts of growth and inflation are still very much two-way. The prudent approach would be to move closer to neutral before stopping to survey the landscape, as the RBA has done. Of course, what constitutes a ‘neutral’ rate is still up for debate. But for argument’s sake let’s say that the RBNZ is currently eyeing a peak in the OCR of about 5% (compared to around 5.75% in its June projections).
If 25 basis point hikes remain the norm, then it will take eight more moves to get from 3% to 5%. Even with no pauses, that would take a fullyear – and there will be a lot more information about the economy to assess along the way. For that reason, we see little value in trying to predict the timing of any pauses within the cycle. The ‘pause’ that really matters will be the one when they stop.
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