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Economic note
No room for error
Thursday, 10 December 2015

Key highlights

RBNZ cuts OCR 25bp to 2.5%; believes that is sufficient to return inflation to target.
Will ease further “if circumstances warrant” – we think they will next year.
We continue to expect a 2% OCR next year; June the earliest for the next cut.
 

Report prepared by:

Jane Turner, ASB Senior Economist
Phone: +64 9 301 5853
Email: jane.turner@asb.co.nz


Implications
The RBNZ cut the OCR 25bp to 2.5%, as widely expected. At this stage the RBNZ sees little need to cut the OCR further. The RBNZ has gone as far as saying further cuts could cause unnecessary volatility, citing sections of the Policy Targets Agreement as a reason for not cutting further to hasten the return of inflation to a more normal level. Gradual is the mantra.

But the RBNZ acknowledged that it would reduce the OCR further “if circumstances warrant”. Our view is the circumstances will warrant further OCR cuts in June and August next year to 2%. We are firmly of the view inflation pressures will not prove to be as strong as the RBNZ currently estimates – and that eventually the RBNZ will respond to that. But we don’t expect the RBNZ to soften its view at the January or even March OCR windows. It will take some time for any stance shift to show through: June is the earliest we would expect the RBNZ to resume cutting.

Comment
The risks to the RBNZ’s inflation forecasts are all clearly skewed to the downside (in our opinion), leaving it little wriggle room. Indeed, a 3-year moving average of the RBNZ’s inflation forecasts (see top chart) shows there is no room for error.
All up, the MPS reads as though the RBNZ is comfortable with inflation not reaching the mid-point of the target band, given its low inflation forecast coupled with a relatively neutral tone.

Moreover, without signalling further cuts, we don’t expect the RBNZ to achieve its TWI forecasts over the first half of 2016. This suggests a further delay to the RBNZ’s much-anticipated tradable inflation lift. The RBNZ still expects the NZD to decline over 2016. With today’s statement being fairly neutral – the NZD actually lifted.

Along with the NZD risk, we also expect the unemployment rate to lift higher than the RBNZ is expecting. Without further rate cuts we also expect growth will be weaker than the RBNZ.

The RBNZ remains frustrated over the strength in the NZD, describing the current level as “unhelpful”. The RBNZ notes further depreciation in the NZD is appropriate to support growth. However, it still expects that the NZD will fall in the medium term and is forecasting the Trade Weighted Index (TWI) to fall to 68.4 by June 2016 (currently the TWI is 73).

The RBNZ’s view on house prices is largely unchanged, however it does note that there are some early signs that Auckland house price inflation is beginning to moderate.

The previous focus on dairy prices has shifted into its discussion of risks to the outlook: “there are risks that dairy prices remain weak for longer.” The Reserve Bank also points out the risks associated with el Nino and the potential for drought to lower agricultural output.

Market reaction
The ‘hawkish’ tone of the RBNZ’s statement (i.e. the near neutral bias compared to market expectations, despite the OCR cut) saw the NZD nearly 1 cent higher against the USD. The TWI has also increased from 72.16 at 8.55am to 73 at 11am. 2-5 year swap rates edged slightly lower this morning, but the 1-year rate remained unchanged.

 

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