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RBNZ at odds with market economists over inflation outlook

Thursday 11th May 2017

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The Reserve Bank isn't convinced inflation pressures are building to such an extent that it needed to tinker with its flat interest rate track, putting it at odds with market economists. 



Governor Graeme Wheeler kept the official cash rate at 1.75 percent, as expected, but surprised some in the market by affirming the bank's neutral bias with the benchmark rate unchanged until September 2019 when it rises to 1.9 percent. A rate hike isn't fully priced in until March 2020 when the OCR is seen at 2 percent. The kiwi has dropped about 1 US cent since the release, recently trading at 68.31 US cents, while two-year swaps fell almost 9 basis points to 2.24 percent and 10-year swaps were down 5 basis points to 3.36 percent. 



Investors had been bracing for an earlier move in the OCR after government data showed annual inflation rose to 2.2 percent in the first three months of the year, and the RBNZ's survey of expectations saw firms raise their view on how quickly consumer prices would rise. However, the Reserve Bank looked through oil and food price spikes in the quarter, which belied more muted underlying inflation. 



Wheeler told Parliament's finance and expenditure select committee that long-term inflation expectations have been anchored, and while there is uncertainty around the inflation outlook the bank isn't seeing much wage inflation and that weaker than expected economic growth in the second half of last year meant there wasn't the same pressure on capacity that they may have been anticipating. 



"The things that have caused us to be different from some in the market that see the need for an interest rate adjustment earlier is that we don't see any sign of significant development in wage acceleration," Wheeler said. "Output growth in the last half of last year was weaker than we thought so we feel that there's a bit less capacity pressure than what we were expecting." 



At the same time, the immediate risks around the global outlook had subsided somewhat with the US President Donald Trump's focus on reforming healthcare and overhauling tax policy, pushing out the debate about trade protectionism that's weighed on open economies such as New Zealand, which are still a big uncertainty hanging over the bank's head. 



The RBNZ's neutral stance and commentary was greeted with scepticism by several economists who insist the central bank will have to move earlier than in 2019. 



Bank of New Zealand head of research Stephen Toplis said he was perplexed that there wasn't "even the slightest nod to a tightening bias" and that the RBNZ risked "being tardy in responding to the economic risks that pervade", while UBS New Zealand economist Robin Clements said the central bank was downplaying the risks from the jump in inflation and that "that the RBNZ is projecting a more favourable mix (higher growth & lower inflation) than we think likely". 



The Reserve Bank painted two alternative scenarios in today's monetary policy statement, one which would require a higher OCR and the other demanding lower rates. If the RBNZ had underestimated capacity pressure, that could push up inflation more rapidly than expected and the central bank said the OCR would need to rise by 2 percent by the end of this year, and 2.25 percent through to the end of its projection. 



On the flipside, if residential investment didn't respond to the high demand for housing as construction capacity pressure rises and lending conditions tighten, the OCR would need to fall to 1.3 percent by the end of next year. 





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