Key Points
- The RBNZ is once again expected to leave the OCR unchanged at 1.75%.
- Recent economic data has generally printed in line with the RBNZ’s view, since the February Monetary Policy Statement six weeks ago.
- International risks remain a concern, with US trade protectionism a risk to global growth.
- The impending start of Adrian Orr’s RBNZ Governorship, and the Policy Targets Agreement he will sign, is overshadowing the OCR Review.
- We expect to see little change in tone from the RBNZ. The bulk of the policy statement will likely remain unchanged.
- We maintain our view that the RBNZ will keep the OCR unchanged until May 2019, before gradually hiking interest rates.
Summary
Since the RBNZ’s February Monetary Policy Statement (MPS), the economy has evolved broadly in line with the Bank’s view. December quarter GDP, while falling just short of the RBNZ’s forecast, is consistent with the Bank’s outlook that growth will remain around trend in the near-term before strengthening. There have been few signs to suggest inflation is set to pick-up materially. The trade-weighted exchange rate (TWI) has averaged close to the RBNZ’s forecast of 75.0, since the February MPS. Thursday’s OCR review is the last policy decision Governor Grant Spenser will oversee. Overshadowing this week’s OCR review is the impending start of Adrian Orr as the new Governor of the RBNZ (March 27), and the new Policy Targets Agreement (PTA) he will sign.
All told, the RBNZ are likely to leave the cash rate unchanged at 1.75% on Thursday, and keep the statement wording broadly in line with the Policy Assessment in the February MPS. We expect limited market reaction. Because the closely-watched final paragraph of the release will remain unchanged, stating: “Monetary policy will remain accommodative for a considerable period”.
Growth broadly on track
The latest December quarter GDP growth fell short of the RBNZ’s latest forecast (see our write-up here). The economy expanded 0.6% in Q4, compared to the RBNZ’s 0.7% qoq, taking annual growth to 2.9% yoy from 2.7% yoy in the September quarter. There wasn’t much in the GDP figures that would concern the RBNZ. Service industries – especially business-related services – carried the economy at the end of 2017, while agriculture faced a challenging start to summer with dryer than normal conditions.
What is more important for monetary policy at this stage is how growth tracks from here. In our view we expect growth to remain around trend (2.5-3.0%) in the opening quarters of 2018 before strengthening from the second half of the year. Construction activity looks likely to slow at the start of the year as capacity constraints return to the fore. Building consents data have slowed, with underlying residential consents easing since September last year. In addition, the services sector, which has been a key driver of growth in recent years, is showing signs of fatigue. Despite weathering last year’s post-election volatility well, the BusinessNZ performance of services index (PSI) has eased in recent months (see chart below) – although still indicative of expanding activity. The PSI came in at 55 in February, the lowest level since last April. Nevertheless, underlying measures of new orders remain elevated at levels around 60, and suggest there is still solid demand for services. We wonder if recent PSI data is starting to indicate a build-up in capacity pressure in the services sector.
From the second half of 2018 we expect to see growth pick-up well above trend and generate rising domestic inflation pressure. Government spending is expected to play a key role, as the Government’s families package kicks in. In addition, the NZ economy continues to experience record terms of trade, low interest rates and solid population growth. As a result, we expect the Bank to keep its sentence on growth broadly unchanged: “GDP growth eased over the second half of 2017 but is expected to strengthen, driven by accommodative monetary policy, a high terms of trade, government spending and population growth.”
All quiet on the inflation front
Since the February MPS, inflation expectations have remained well anchored, while near-term CPI inflation is looking softer thanks to weaker food price inflation. Encouragingly for the RBNZ, their own survey of expectations showed that inflation expectations lifted in the March quarter despite the surprise drop in headline inflation at the end of 2017. The two-year-ahead measure of CPI inflation expectations lifted from 2.02% to 2.11%. In contrast, ANZ’s February Business Outlook survey did show a slight pullback in pricing intentions and inflation expectations. However, the fall in pricing intentions was nothing too dramatic and remains consistent with anchored inflation expectations. Recent indicators, such as the food price index, do potentially point to a softer CPI outturn in the March quarter than the RBNZ’s 1.1% forecast. However, we don’t expect recent inflation data to have altered the RBNZ’s view that ultimately “CPI inflation is forecast to trend upwards towards the midpoint of the target range”. The food price index fell 0.5% mom in February, following a smaller than usual 1.2% mom rise in January. On an annual basis, the food price index was broadly flat, down from a 3% yoy increase seen in September 2017.
The currency has tracked in line with the RBNZ’s Feb MPS forecasts over the March quarter to date, with the Trade-Weighted Index (TWI) averaging at around 75 (see chart below). The Bank’s outlook for tradables inflation is likely to therefore remain intact.
International developments continue to pose risks
In recent week’s we have seen worrying developments regarding trade protectionism in the US. The Trump administration has signed off on import tariffs on steel and aluminium entering the US – although somewhat watered down from the initial statement and excludes both Canada and Mexico. This development has raised the possibility of retaliatory action and the start of a global trade war, in which NZ could get caught in the crossfire. We would expect the RBNZ to make mention of this development in Thursday’s one-page statement given the risks an escalating trade war would have on NZ’s economy. However, this is likely to be noted as a risk for now.