UPDATE: Wheeler reins in exuberant rate-cut forecasters, kiwi above 67 US cents

Wednesday 29th July 2015

Reserve Bank governor Graeme Wheeler has signalled the need for moderate further interest rate cuts in the year ahead, while predicting inflation will accelerate to the level the bank targets in the next nine to 12 months. The kiwi dollar rose after he said some forecasters were flagging deeper rate cuts than were needed.

Wheeler gave a balanced view of the economy in a speech to an ExportNZ/Tauranga Chamber of Commerce meeting. While repeating that further depreciation in the New Zealand dollar is necessary "given the weakness in export commodity prices and the projected deterioration in the country’s net external liabilities over the next two years," he also noted several factors supporting the economy - "the easing in monetary conditions, continued high levels of migration and labour force participation, ongoing growth in construction, and continued strength in the services sector.”

"Some local commentators have predicted large declines in interest rates over coming months that could only be consistent with the economy moving into recession," he said in speech notes posted on the central bank's website.

The kiwi dollar climbed as high as 67.38 US cents after the speech was released and was recently at 67.06 cents, up from 66.84 cents immediately before. The trade-weighted index rose to 71.30 from 71.04.

Wheeler cut the official cash rate a quarter point to 3 percent last week, the second 25 basis point cut in two months, and flagged further declines. Bank economists have predicted he will cut the rate to 2.5 percent this year, with some saying he may have as much as 1 percentage point of cuts up his sleeve.

"The RBNZ speech reinforced that further easing is likely, but also explicitly dampened the more exuberant OCR cut expectations," said Nick Tuffley, chief economist at ASB Bank. "We remain comfortable with our view the RBNZ will cut the OCR by 25 basis points in both September and October, to 2.5 percent."

Wheeler said today that the exchange rate "remains above the level consistent with current economic conditions" and that there is potential for further downward pressure on prices of dairy products, the nation's biggest export. But a decline in the currency may be assisted by factors outside his control, including that the US Federal Reserve and the Bank of England are likely to begin the process of normalising their interest rates, "which could assist our currency lower,” Wheeler said.

New Zealand's annual inflation is just 0.3 percent - below the bank's 1 percent to 3 percent target band. Wheeler said today that annual CPI inflation is expected to be close to the midpoint of the band by the first half of 2016.

"The rise in headline inflation is expected to mainly come through higher tradables inflation, due to the 14 percent decline in the trade-weighted exchange rate since mid-April and as the decline in oil prices drops out of the annual figure," he said. "Under the bank’s flexible inflation targeting framework, the policy targets agreement specifically recognises that annual CPI inflation will fluctuate around the medium-term trend due to factors such as exceptional movements in commodity prices – like those experienced since mid 2014,” Wheeler said.

"There are, however, several risks and uncertainties around the inflation outlook. These include the future path of the exchange rate, which will be influenced by future commodity prices, and the speed with which the recent depreciation feeds through to higher inflation.”

BusinessDesk.co.nz

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