RBNZ may follow market pricing and keep powder dry on rate cuts this week

Monday 8th June 2015

The odds of the Reserve Bank cutting interest rates this week are less than 50 percent, based on market pricing, but with economic indicators printing weaker since the bank’s April 30 review it is expected to explicitly signal a cut in coming months.

Governor Graeme Wheeler will keep the official cash rate at 3.5 percent, according to a Reuters survey of 14 economists. None expect an increase. Traders put a 43 percent change on a rate cut this week, based on the overnight interest swap curve, and see 49 basis points of cuts in the next 12 months.

Wage inflation slowed in the first quarter, business confidence has dropped to an eight month low and dairy prices have continued to slide since the end of April. But to reduce the OCR, Wheeler would need to be satisfied that a series of policies rolled out by the central bank and the government aimed at cooling the Auckland housing market will be enough to counter the effect of lower borrowing costs.

“While we acknowledge that June is a material risk for an OCR cut, we continue to expect the RBNZ to hold off cutting the OCR until later in 2015 (September and October),” said Nick Tuffley, senior economist at ASB. “We expect the RBNZ will want to wait for additional data on price setting behaviour and clear signs of slowing growth before cutting the OCR.”

Wheeler moved to an easing bias in April, when he left the OCR unchanged, saying “It would be appropriate to lower the OCR if demand weakens, and wage and price setting outcomes settle at levels lower than is consistent with the inflation target.”

The March monetary policy statement projected annual inflation to remain below the midpoint of the bank’s 1 percent to 3 percent target for the next two years, peaking at 1.7 percent, and projected the 90 day bank bill rate to stay at 3.7 percent on average through that time.

Should Wheeler keep the OCR unchanged as expected this week, he could still lower the forecast track of the 90 day bank bills to underline his easing bias.

“In general, the underlying inflation outlook has softened since both the March MPS and the April OCR review,” Tuffley said. “Consequently, we expect the RBNZ 90 day interest rate outlook to imply at least one 25 basis point cut with a new low point of 3.5 percent or less.”

One ‘bright spot’ for the Reserve Bank is the kiwi dollar, which has weakened to 74 on the trade weighted index – below the 76.7 average the bank projected for the June quarter back in March. That may cause Wheeler to soften his language of late that the currency is “unjustifiably high and unsustainable in terms of New Zealand’s long term economic fundamentals”.

But keeping the OCR unchanged also risks lighting a fire under the local dollar, with at least some in the market positioning for a cut.

“In our view, the recent depreciation of the TWI is part and parcel of the market’s move to price in 50 basis points of OCR easing over coming meetings,” said Darren Gibbs, chief economist at Deutsche Bank. “We think the exchange rate will readily regain this ground if the RBNZ does not ease the OCR on 11 June or at least indicate that policy easing is imminent.”

Gibbs is among economists forecasting a cut this week.

“We think that developments in the supply side of the economy will be a key driver of policy action, in particular continued greater than expected slack in the labour market and lower than expected labour cost inflation,” he said. Economic growth is unlikely to be as fast as the 3.8 percent year ahead rate forecast in the March MPS, he said.

ASB’s Tuffley acknowledges there’s a risk that the “Wheeler factor” results in a cut to the OCR this week.

“If he decides that inflation risks [are] deviating too long from the PTA, he might make the decision to cut in June, regardless of how supportive any economic forecasts might be at present,” he said.

BusinessDesk.co.nz

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