We expect another 25bp hike at Thursday’s OCR review, with a slightly more subdued assessment compared to the June Monetary Policy Statement.  Since June the economic news has generally been on the weaker side of expectations – not hugely so, but the shortfalls have been widespread. In terms of the major data releases (which we can compare directly to the RBNZ’s forecasts), two have undershot slightly and one was stronger.

March quarter GDP grew by 0.6% against the RBNZ’s forecast of 0.8%, with the difference likely coming from a subdued consumer. Top-down indicators to date suggest that the June quarter will also fall short of the RBNZ’s previous forecast of 1.1%. Together, that suggests a starting point for the economy with less inflation pressure than expected.

June quarter CPI was also lower than forecast, taking the annual inflation rate down to 1.8%, although the RBNZ will take some mixed messages from the details. Food prices have fallen, and the strength of the NZ dollar over the last year is still being passed through to the prices of many tradable goods. However, non-tradables prices (in particular housing-related costs) rose by more than the RBNZ expected.

On the plus side, the export sector continues to benefit from high commodity prices and solid demand growth. That saw the current account deficit narrow to 2.4% of GDP, much lower than the RBNZ forecast of 3.3% (with about half of the surprise coming from the trade surplus). So all together, the data points to a continued rebalancing of the economy, with the contrast between weak consumption and strong production even greater than thought.    

On top of these, more recent data has pointed to subdued retail spending, a soft housing market, and slowing net migration inflows (the latter perhaps contributing to the first two). Business confidence has dipped recently, but it remains at levels that are consistent with recovery.

Financial developments since June have been mixed. The NZD trade-weighted index has averaged about 3% higher than the RBNZ assumed, but global credit market conditions have been steadily improving. The June OCR hike was not fully reflected in short-term mortgage rates, and fixed-term rates for two years or more have actually fallen outright.

The RBNZ’s statement is likely to be peppered with references to the weaker developments since June. However, we think that the ‘bias’ paragraph – the crucial part of the message, at least from the market’s point of view – will be left largely intact. In June that paragraph read:

“Given this outlook and as previously signalled, we have decided to begin removing some of the monetary policy stimulus that is currently in place. The further removal of stimulus will be reviewed in light of economic and financial market developments.”

Keeping the first sentence would hark back to the June MPS projections, which pointed to the OCR rising from a low of 2.5% to a more ‘neutral’ level of 5.5-6.0% over the next two years. The RBNZ has spent many months making the case that interest rates will need to be normalised as the economy improves. There is nothing in the recent data that would warrant a change to the end-point of that plan, though it perhaps argues for less front-loading of hikes.

The phrase “removal of stimulus” will definitely be retained – the RBNZ is aiming to deflect criticism by portraying rate hikes as taking the foot off the accelerator rather than hitting the brakes.

Finally, the last sentence of the paragraph was fairly non-committal for a central bank projecting 300 basis points or more of hikes over the next two years. We think it was meant to imply “don’t automatically assume another hike in seven weeks”, and that seems like a reasonable message to convey this time as well – even if a followup hike is more likely than not.

Interest rate markets have fully factored in a 25bp hike next week, and pricing for the next year is broadly in line with the RBNZ’s June projections – a touch lower if anything. We expect that a 25bp hike with an unchanged ‘bias’ would see a modest rise in wholesale interest rates – no more than 5bps. The NZD remains beholden to sentiment in global equity markets, so the OCR decision is unlikely to have a sustained impact.

This week’s data releases are likely to paint a mixed picture, but one that can be shoehorned into the ‘rebalancing’ story.  Business confidence (Wed) eased from its highs in May, and a less formal survey by BNZ suggested a sharp fall in June (though this may be more highly weighted towards the property market). Recent indicators point to tough conditions for retailing and construction, but steady gains in manufacturing.

Merchandise trade (Thurs) is expected to record a June surplus for the first time since 2002, despite the autumn drought now weighing on the volume of dairy exports. Imports continue to grow steadily but slowly, with the higher exchange rate still dampening prices compared to a year
ago.

Finally, housing consents for June (Fri) are expected to recover from a nearly 10% drop in May, which may have been partly due to trading day effects. Apartment consents are already at rock-bottom levels, so the risk is always for a sharp bounce in any given month.

Fixed vs. floating:
Last month, as was widely anticipated, the RBNZ kicked off what we expect to be an extended tightening cycle. Nevertheless the decision to fix or float remains finely balanced.  Floating rates remain lower than shortterm 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 advantage 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.

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Past Westpac Weekly Commentary
Westpac Weekly Commentary 19 July 2010  >>
Westpac Weekly Commentary 12 July 2010  >>