Kiwibank predicts Reserve Bank will cut interest rates next week to bolster inflation

Tuesday 1st March 2016

Kiwibank is betting the Reserve Bank of New Zealand will cut interest rates at its meeting next week, becoming the first local bank to officially put its stake in the ground for a move this month.

The state-owned lender, a division of New Zealand Post, today changed its view, predicting the RBNZ will cut interest rates by 25 basis points in March and June to take the benchmark to a record low 2 percent, compared with its previous view that rates would remain on hold at 2.5 percent for the remainder of this year.

Reserve Bank governor Graeme Wheeler cut the benchmark four times last year and in his review of the official cash rate in January, he opened the door for further cuts, having indicated he was done doing so in the December monetary policy statement. Last month, he repeated that some further policy easing may be needed over the coming year to nudge future average inflation back to the 2 percent mid-point of the 1 percent to 3 percent band in the policy targets agreement.

"Over the past month, we have seen several pieces of data that have convinced us of the need for a lower OCR to ensure that the RBNZ can meet its policy targets over the medium term, these include; significant fall in inflation expectations, waning business confidence, a lower global growth outlook and strong gains in the New Zealand dollar," Kiwibank senior economist Zoe Wallis said in a note titled 'Shifting sands'.

"The global growth outlook has weakened at the same time as dairy prices continue to fall and the New Zealand dollar remains elevated - reducing New Zealand's growth and inflation outlook," she said.

"Given the changes in the domestic and global environment, we now anticipate that the RBNZ will need to further cut the OCR down to 2 percent in coming months. While there are some arguments in favour of waiting, we see 25bps rate cuts in March and June as the most reasonable response to the shifting outlook."

Traders are currently pricing in about a 30 percent chance of a rate cut at the Reserve Bank's March 10 meeting. A 25bps cut is fully priced in for June, with a 50 percent chance of another cut by the end of the year, Wallis said.

Kiwibank noted that the Reserve Bank has taken great pains to emphasise the flexibility around inflation targeting in its PTA. It has a mandate to keep future inflation between 1 percent and 3 percent on average over the medium term, with a focus on keeping future average inflation near the 2 percent target midpoint, and to monitor asset prices, having regard to the efficiency and soundness of the financial system.

"However, the body of evidence is now highlighting the significant downside risks to the RBNZ’s inflation target over the medium-term," Wallis said. "We now believe that the downside risks to growth and inflation are significant enough to outweigh the financial stability risks."

The Reserve Bank has been hesitant to reduce interest rates further amid concerns about the financial stability risks of an overheated Auckland housing market. However monetary policy concerns now took precedence and the central bank would likely use further macro-prudential policies such as high-debt mortgage lending restrictions to further cool the housing market if needed, Wallis said.

In addition to the economic factors, market funding spreads had widened, meaning banks are facing increased marginal costs in order to obtain funding. This is likely to be passed on to customers, creating tighter monetary conditions through higher borrowing rates, she said.

BusinessDesk.co.nz

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