The decision to leave the official cash rate at 3% today came as no surprise. The interesting part of the statement from Reserve Bank governor Alan Bollard was his comments around monetary policy tightening, in other words, when will the OCR and home loan rates start rising.
Bollard said "While it is appropriate to keep the OCR on hold today, it remains likely that further removal of monetary policy support will be required at some stage."
This statement will give some comfort to borrowers on floating and short term interest rates, but it doesn’t give a lot of certainty around the timing of increases.
Economists maintain the view that the next OCR increase won’t happen until March. However a view starting to emerge today is that when increases start they will be bigger and higher than are currently being forecast.
Westpac says, “we expect that by the second half of next year the OCR will be rising further and faster than the RBNZ's current projections.”
It is a view echoed by others.
The following are comments from various bank economists on today’s announcement.
If this statement was aimed at minimising the disturbance to markets, the RBNZ will be pleased with the response. The two-year swap rate rose 4 basis points after the release, although this probably reflected a catch-up to overnight movements in global markets.
Current pricing is consistent with the next hike occurring in April next year. NZD/USD was little changed at 0.7450. Given the uncertainty about global conditions, and the fact that the domestic recovery to date hasn't lived up to its early promise, it's understandable that the RBNZ would pause for a while to assess the situation.
Moreover, the RBNZ has made some big assumptions as part of its central forecasts: that households will further increase their rates of saving; that inflation expectations will decline even as headline inflation rises above 4%; and that the rise in the terms of trade will only be temporary.
These assumptions will need a lot of accumulated evidence to either prove or disprove. We expect the next OCR hike to be delayed until March, as do most forecasters.
That said, we can't ignore the massive improvement in New Zealand's purchasing power resulting from the continued strength in world demand for commodities.
If this has anything like its usual effects on the broader economy, it's hard to see consumers remaining reticent, or wage and price expectations remaining contained, for as long as the RBNZ is assuming.
As a result, we expect that by the second half of next year the OCR will be rising further and faster than the RBNZ's current projections.
The RBNZ has for now stuck with its view that its medium-term outlook for the economy is unchanged, despite activity data being on the low side and Q3 inflation being on the high side of its expectations. On the activity side, the RBNZ had previously cut back its domestic spending outlook considerably, and going forward we judge it will be hard for data to continue to underperform that outlook. On the inflation front, we continue to view the RBNZ as being too sanguine about the medium-term outlook. Between now and March we expect that view will progressively change, particularly as inflation expectations and Q4 CPI are published.
The open-ended wording of the statement's conclusion gives the RBNZ flexibility to start hiking again when it sees fit, instead of being pinned to a particular timeframe. We continue to expect the RBNZ will resume lifting the OCR in March. An earlier start would require clear signs the economy and/or inflation pressures are a lot more resilient than the RBNZ is currently assuming.
Market pricing in our view remains on the light side, both for the resumption of the tightening cycle and the eventual peak. Eventually this will change, but in the short term there appears to be very little catalyst.
There were no surprises in the RBNZ's October OCR review this morning, which was essentially a repeat of the general message from the more comprehensive Monetary Policy Statement issued in September: interest rates are on hold for now but are likely to push higher through 2011. The RBNZ certainly acknowledged the generally disappointing data, but also highlighted that the medium-term outlook for the economy remains broadly in line with the September MPS projections. These projections implied the OCR would start rising again around March 2011. Today's statement effectively endorses this view - a view that we share. However, we anticipate interest rates to eventually push higher through 2011 than either the RBNZ currently projects or the market currently has priced in.
RBNZ Governor Alan Bollard this morning left the official cash rate (OCR) at 3% (J.P. Morgan and consensus: no change) as unanimously forecast by all economists surveyed by Bloomberg. Indeed, the poor run of economic data, which has "turned out weaker than projected", meant there was little chance of a rate hike today. The recovery in New Zealand effectively has stalled; hence, the accompanying statement was suitably downbeat on the domestic economy.
We believe that the RBNZ Governor will leave current policy settings in place for some time in order to encourage a sustainable recovery. The Governor reiterated today that "further removal of monetary policy support would be required at some stage." Our base case is for the next rate hike to be delivered in March 2011, although we acknowledge the risk that the next move could be delayed if current accommodative policy settings are still required to prop up growth in the New Zealand economy.
Unlike the statement accompanying the last OCR announcement, in which a significant amount of time was spent discussing the impact of the devastating earthquake in the Canterbury region in early September, the statement today focused primarily on the string of disappointing economic indicators. The Governor acknowledged that households had become more cautious and, as a result, consumer spending had softened, as had housing market activity. We suspect that this caution will persist, particularly with employment and wage growth subdued and credit demand non-existent.
A prolonged period of household consolidation should, though, keep inflation in check. The Governor appears comfortable with the current price environment. Though headline inflation is expected to move higher, underlying inflation should remain well-behaved as long as domestic demand remains weak. The forthcoming inflation spike (resulting from the GST-hike on October 1) will push headline inflation up sharply, but will have a muted impact on medium-term inflation given that firms have little pricing power. With firms' pricing intentions steady, and inflation expectations contained, RBNZ officials can afford to "look through" the spike in headline inflation cause by the one-off price hike.
There appears no sense of urgency for the Governor to step away from the current stimulus. Economic activity in the third quarter will remain subdued. Owing to the damage caused by the earthquake, confidence will take a hit, spending will be reined in, retail stores will be closed temporarily, and employees left unable to work. The external sector will be required to pick up the slack. Indeed, RBNZ officials continue to bank on a shift to a more export-led recovery and continued high export prices to offset sluggish domestic demand. The Governor acknowledged today that downside risks to global growth continue, but that growth in New Zealand's major trading partners remained strong, particularly in Australia. The good news on this front is that at least some of NZD strength vis-à-vis the US dollar is being offset by weakness against AUD.
Before the RBNZ's December OCR announcement, probably the key piece of information to watch for will be the RBNZ's 4Q inflation expectations survey. One year inflation expectations likely will remain significantly above the RBNZ's target 2%-3% range, but given firms have little pricing power, two-year inflation expectations probably will remain within the Bank's comfort zone.