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MPS Preview: NZ central bank unlikely to rush rate increases

Monday 8th March 2010

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The Reserve Bank of New Zealand is likely to keep the official cash rate at a record low 2.5% this week and reiterate its view that tightening can occur around the middle of the year as the economy continues its tepid recovery with little inflation.

No change in the OCR is the view of all 16 economists in a Reuters survey, with 15 of them tipping a higher interest rate by June 30. Economists are split on the pace of interest rate hikes once they do get underway.

Seven of those in the survey see a 25 basis point increase by the end of June, six are predicting a 50 basis point move and two are calling for 75 basis points.  By the end of the year, Bollard will have lifted the OCR by 1.75 percentage points, according to the median estimate. 

A mixed bag of data since the December Monetary Policy Statement has prompted economists to wind back their expectations for the timing of rate increases, which some had called for as soon as next month. 

The housing market has weakened (with QV Valuations data today showing a slowing in the pace of growth in property values), unemployment may have peaked at a higher-than-expected 7.3%, and consumer prices fell in the fourth quarter. 

“Despite weak spots in some of the recent data, the RBNZ is likely to conclude that the recovery is proceeding on track with their December MPS forecasts,” said Brendan O’Donovan, chief economist at Westpac Banking Corp., in a report.

“Evidence of stubborn inflation pressures” may point to “a steeper profile of rate hikes for the first year or so.” 

Consumer prices dropped 0.2% in the fourth quarter, matching the central bank’s forecast but surprising most economists, who had expected an increase. Since then, data has showed prices creeping up and more companies expecting to raise prices.

The central bank’s Survey of Expectations has annual inflation accelerating to 2.7% in the next two years, nearing the top of the bank’s 1%-to-3% target range. 

The National Bank Business Outlook last week showed confidence at a 10-year high and companies becoming more bullish about their own activity. Traders see 1.4 percentage points of increase in the OCR over the next 12 months according to the Overnight Index Swap curve.

That’s down from October, when increases in the OCR amounting to 2.4 percentage points were expected within 12 months. “For the first time in some time, we suspect the RBNZ will be comfortable with current market pricing,” said Philip Borkin, New Zealand economist at Goldman Sachs JBWere.

“There will be a lack of desire on the RBNZ’s part to upset the apple cart” and this week’s MPS “will be very similar in tone” to the January OCR review with risks “skewed towards a later start.” 

Keeping the OCR at 2.5% will maintain Australia’s rate advantage at 1.5 percentage points after the Reserve Bank of Australia extended its tightening last week by lifting its cash rate to 4%.

The rate gap, coupled with data showing Australia’s economy is on a tear, has helped drive the kiwi dollar to a 10-year low against its Australian counterpart. 

“Their recovery has been faster, stronger, broader than ours,” said Keith Poore, head of investment strategy at AXA Global Investors in Wellington. Still, the rate gap is likely to reverse out over time, he said.  

“There’s no way we (New Zealand interest rates) will be permanently under Australia” given the premium demanded for ‘smaller-country’ risk, still-large current account deficit and concentration of overseas income in the hands of one exporting giant, Fonterra Cooperative Group, he said. 

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