Key Points:- As widely expected, the RBNZ left the OCR unchanged this morning at 1.75% and maintained a neutral tone.
- The RBNZ kept the final paragraph of the statement entirely unchanged from the February MPS, noting that interest rates will remain stimulatory for a “considerable period”.
- The biggest risk to the Bank’s outlook remains from the international environment, with numerous uncertainties surrounding the global economy and politics.
- We maintain our call for the OCR to be on hold for an extended period at 1.75%.
Summary
The RBNZ left the OCR unchanged this morning at 1.75%, as widely expected. While acknowledging the recent data developments, the Bank maintained a very neutral tone, with the closely scrutinised final paragraph of the statement unchanged. The Bank repeated that there are “numerous uncertainties” around the current outlook. Recent comments in a speech from RBNZ Governor Wheeler suggested that the risks to the interest rate outlook are balanced (i.e. an equal chance of the OCR going up or down in the near-term.
We maintain our view that the next move in the OCR will be higher and see the balance of risks as more skewed toward the upside. There is absolutely no rush for the RBNZ to raise the cash rate based on the current economic fundamentals we are watching. However, there are a couple of risks that could shift our view. One would be if we see further sustained declines in the NZ TWI over coming quarters. A lower currency would push up the cost of imported goods and hence send tradables inflation and headline inflation higher. The other factor would be if we continue to see a sustained improvement in the global economy and fiscal policy in the US ends up being net positive for the US and global economy (i.e. a focus on fiscal stimulus and corporate tax cuts, rather than shutting borders and constraining international trade).
The market reaction to today’s statement was almost non-existent. Interest rates are essentially unchanged, with the NZD/USD down slightly to $0.7050.
Domestic outlook remains positive
Since the RBNZ released its last full set of forecasts in February, we have seen a couple of key local data developments. Two key ones have been softer GDP growth in the second half of 2016, and rising inflation pressure in the March 2017 quarter.
Economic growth came in weaker than expected in the December 2016 quarter, with annual GDP growth easing to 2.7% yoy from 3.5% yoy seen in the June quarter. The means economic activity is now growing at around trend, rather than being comfortably above as we had previously believed to be the case.
Some of the recent weakness in growth relates to temporary factors (as the Bank noted this morning), which are expected to at least partly reverse in coming quarters. The 2016/17 dairy sectors got off to a slow start in the second half of calendar 2016 due to adverse weather conditions, lowering agriculture production and flowing through to weaker food-related manufacturing. We have already seen an improvement in dairy production over the summer, with Fonterra revising up its outlook for the 2016/17 milk collection (although it is still expected to be down 3% over the season). We expect that GDP growth will pick up over 2017, as the NZ economy continues to be supported by strong migration-led population growth, a buoyant tourism sector and accommodative monetary policy. However, we don’t expect economic growth to get up to the 4% yoy rate that the RBNZ was forecasting by mid-2017. In addition, capacity pressures now appear to be limiting some of the potential upside in certain sectors such as construction and tourism. With economic growth looking somewhat softer, domestic inflation pressures are likely to be slightly weaker over the medium term than previously thought.
We have seen near-term indicators of inflation pointing to a 0.8% qoq rise in the CPI over the March quarter, taking annual inflation back to the 2% middle of the RBNZ’s target band – much earlier than the RBNZ had forecast in the February MPS. The Bank noted in this morning’s statement “headline CPI will be variable over the next 12 months…”. As with GDP growth some of the drivers of inflation are temporary in nature, such as an unseasonal jump in fruit and vegetable prices. Looking through the near-term lift in headline inflation we see underlying inflation pressure as remaining at around an annual rate of around 1.5-2% over the next year (absent a significant decline in the NZ TWI).
Housing market moderates, but for how long?
National house price appreciation has slowed in recent months, with REINZ’s house price index rising by 10.5% yoy in February compared to almost 15% yoy in November last year. The RBNZ noted that recent LVR tightening on investor related lending and tighter lending conditions are drivers. Mortgage rates have crept higher in recent months and are also likely to be capping some of the demand around the edges. However, the RBNZ remained sceptical that house price inflation would slow further given supply/demand imbalances (with supply/demand issues in Auckland the main concern).
International developments the biggest threat
The outlook for the global economy remains the biggest threat to the NZ economy, and numerous uncertainties remain. The Bank noted that the global macro-economic picture has improved in recent months, and we have seen inflation rates, PMI data and other forward looking indicators improve for many major economies. However, it remains early days and political uncertainty continues to plague the US and Europe. The RBNZ’s language on the geo-political risks stepped up from “rising geopolitical uncertainty” to “extensive geopolitical uncertainty”. At the same time, the Bank’s view on global monetary policy was unchanged with the expectation of gradual withdrawal of monetary policy stimulus - particularly in the US. Rising global commodity prices in the last 3-6 months have helped to push headline inflation rates higher, but with the recent sharp decline in oil prices (down 10% in the past couple of weeks) this could reassert downward pressure on inflation again. At the same time core inflation globally remains “low and stable” and with on-going slack in many developed economies, this is unlikely to turn around quickly.
Full Statement
“The Reserve Bank today left the Official Cash Rate (OCR) unchanged at 1.75 percent.Macroeconomic indicators in advanced economies have been positive over the past two months. However, major challenges remain with on-going surplus capacity in the global economy and extensive geo-political uncertainty.
Global headline inflation has increased, partly due to a rise in commodity prices, although oil prices have fallen more recently. Core inflation has been low and stable. Monetary policy is expected to remain stimulatory, but less so going forward, particularly in the US.
The trade-weighted exchange rate has fallen 4 percent since February, partly in response to weaker dairy prices and reduced interest rate differentials. This is an encouraging move, but further depreciation is needed to achieve more balanced growth.
Quarterly GDP was weaker than expected in the December quarter, but some of this is considered to be due to temporary factors. The growth outlook remains positive, supported by on-going accommodative monetary policy, strong population growth, and high levels of household spending and construction activity. Dairy prices have been volatile in recent auctions and uncertainty remains around future outcomes.
House price inflation has moderated, and in part reflects loan-to-value ratio restrictions and tighter lending conditions. It is uncertain whether this moderation will be sustained given the continued imbalance between supply and demand.
Headline inflation has returned to the target band as past declines in oil prices dropped out of the annual calculation. Headline CPI will be variable over the next 12 months due to one-off effects from recent food and import price movements, but is expected to return to the midpoint of the target band over the medium term. Longer-term inflation expectations remain well-anchored at around 2 percent.
Monetary policy will remain accommodative for a considerable period. Numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly.”