Traders less certain NZ will follow Australia and cut rates; no change seen at next OCR review

Friday 8th June 2012

Traders have pared their bets that the Reserve Bank of New Zealand will follow Australia in cutting interest rates though global risks, especially Europe, and a tepid local recovery will keep the official cash rate unchanged next week and right through 2012.

Governor Alan Bollard will keep the OCR at 2.5 percent with his quarterly Monetary Policy Statement on June 14, according to all 14 economists in a Reuters survey. The bank will lift its benchmark rate a quarter point to 2.75 percent by March 2013 and to 3 percent by June, the poll shows.

Keeping rates unchanged next week means Bollard will be making a different call than his Australian counterpart, Glenn Stevens, who this week cut the cash rate target 25 basis points to 3.5 percent. As of today, markets were pricing in 17 basis points of cuts in New Zealand’s OCR over the next 12 months, having pared their bets from 44 basis points at the start of the week.

That’s the smallest gap between the benchmark rates since November 2009. Bank of New Zealand head of research Stephen Toplis says New Zealand’s economy is on “a modest growth path” but with the potential for inflation to accelerate from a lower base than usual. “It would be unwise for the RBNZ to cut interest rates in the manner that the market has been trying to price,” Toplis said in a report.

“If Europe implodes, as it may well do so, then all bets are off” though the central bank would be better to be reactive than proactive if the euro zone does deteriorate. In the 13-year history of the OCR, there’s been only one other period, 2006, when the benchmark interest rate has stayed unchanged for such a period – 10 consecutive reviews.

There are too many unknowns globally for the RBNZ to act quickly, says Dominick Stephens, chief economist at Westpac, in his OCR preview. If Europe turns out to be “a disaster zone” the central bank would want to have rate cuts up its sleeve to boost confidence rather than ‘spend’ them now.

If Europe scrapes through, a rate of at least 2.5 percent would be more appropriate as the domestic economy grows and the price pressure from rebuilding Christchurch becomes evident, Stephens says. “The wild uncertainty of the international situation… incentivises the Reserve Bank to adopt a wait-and-see approach,” he said.

Monetary conditions are now easier than they were in the weeks following the March MPS. The trade-weighted index is about 4 percent weaker than it was on March 8. Two-year swaps have shed about 56 basis points from their high on March 20, which Stephens says is the cause of a decline in fixed mortgage rates.

The two-year swap rate dipped below the OCR fro two weeks last month. Westpac’s Choices Fixed two-year home loan is 5.49 percent, or about 75 basis points below the lender’s floating rate mortgage. Lower home loan rates may help revive New Zealand’s housing market, which has strengthened in Auckland and Christchurch.

“The housing market remains undersupplied, and indicators continue to point to growing house price inflation,” said ASB chief economist Nick Tuffley, who expects the RBNZ to “remain very cautious.”

Commodity prices have fallen, most notably for dairy products, employment figures have been “disappointing” and the domestic economy “fairly soft”, though housing market pressure is beginning to return, Tuffley said.

“Risks from offshore events will have replaced the high exchange rate as the main focus” in next week’s monetary policy statement, Tuffley said.

“We expect the RBNZ to push out the timing of OCR increases to the first half of 2013, but with a lower NZD providing the majority of additional stimulus needed, we expect a fairly similar 90-day projection beyond this. The 90-day bank bills were recently at 2.63 percent – below the 2.8 percent rate that the RBNZ forecast in its March MPS. The trade-weighted index is at 69.87 versus the MPS forecast of 72.3.

BusinessDesk.co.nz

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