RBNZ Cash Rate Review - No change expected
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RBNZ Cash Rate Review: No change expected
* The status of the interim reviews
The RBNZ formally reviews monetary policy settings on 8 occasions during the year. Four of these take place against the full review of the economic and inflation outlook published in the Monetary Policy Statements. In the RBNZ's own words, "the quarterly Monetary Policy Statements.will continue to be the main vehicle for substantive policy assessment."
The purpose of the other four reviews is to allow the Bank to react to developments. In the March MPS the Bank stated that the "OCR reviews between Statements will allow the Bank to react to any major unexpected events in a timely way. They will also give the bank the ability to adjust the OCR incrementally, if the key uncertainties are such that caution is warranted."
With the RBNZ only having moved the OCR once (at the November MPS), it is unclear how high the hurdle is for a move at the interim reviews. In various Q&A sessions, Bank officials have indicated what we would interpret as a reasonably strong preference not to move the OCR at an interim meeting. The RBNZ's own research also indicates that policy decisions taken in the absence of a full review of the inflation outlook can often be mistakes and add unnecessarily to volatility. This suggests the hurdle for a move between Monetary Policy Statements is very high. However, the RBNZ has made a concerted effort in recent discussions to emphasise it has not ruled out moving at an interim review.
* Is there a case for moving on 19 January?
In the November MPS, the RBNZ clearly signalled an intention to move the cash rate up by at least 50 bp in the first half of 2000. The Bank also assumed a jump in the exchange rate would help lift overall monetary conditions, as the "temporary" factors thought to be restraining the NZD subsided.
Since the publication of the November MPS, the activity data has generally been stronger than the Bank expected. For instance, GDP grew 2.3% in Q3 compared with the RBNZ's forecast of a 1.3% increase. At the same time, the NZD has struggled to perform. At times the MCI has fallen below -500. It presently sits at -340, which contrasts with the -175 level average assumed by the RBNZ to prevail over the first half of 2000.
The Bank could argue that given the strength of the activity data, monetary conditions should be tighter than previously assumed rather than easier. With the NZD not pulling its weight, interest rates will have to play a bigger role. With another two months to go before the release of the March MPS, an increase in the OCR in January can be presented as a sensible step toward higher interest rates.
The fact that a rate increase in January would the second of a series, rather than an initial move, also makes it somewhat easier to contemplate.
* The case for not moving on 19 January
On the other hand, the price data have been subdued. Errors in the calculation of the September quarter CPI saw it revised from the previously published 0.6% down to 0.4%. Despite the weakness of the NZD, import prices were reported as falling 0.6% in the year to September (though we have our doubts about the validity of the data).
While Q3 GDP was strong, at least some of the strength reflected the weakness of the June result. The economy is growing at a 4% pace, not something close to 10%!
As far as the outlook for the NZD is concerned, it is too early to conclude that it will not continue to rebound. The TWI has already risen some 4% from the low in mid-December.
The RBNZ's own research suggests that policy decisions made without the benefit of a full review of the economic outlook are more likely to produce errors than decisions made after such a review. Thus, such decisions should only be taken under compelling circumstances. We don't think these circumstances exist. By moving on 19 January, the RBNZ will lift the status of the interim reviews and return investor focus to the difference between the RBNZ's expectations for historical data and the actual outcome.
The timing of the review is also unfortunate. The CPI for Q4 is published at 10.45am the same morning. The RBNZ will not have access to that data in advance, so there is a risk inflation surprises on the downside.
Of course, the Bank would argue that historical inflation numbers have little impact on its assessment of medium-term inflation pressures. Thus, the December quarter CPI outcome is irrelevant for the setting of monetary policy. A similar argument can be made about the September quarter GDP result. Does the publication of one GDP number fundamentally change the medium-term outlook? It didn't when GDP fell in the June quarter. While historical CPI numbers may not be all that important for the medium-term outlook, a surprisingly low number will have a negative impact on the RBNZ's credibility if the bank has just tightened.
* The market reaction if the RBNZ does move
The bill strip currently has a 25 bp rate hike in January priced in. This could be interpreted as meaning that the market reaction to a rate hike would be minimal.
We very much doubt this would be the case. Few, if any, market commentators are expecting a rate hike despite what the market "seems" to be pricing in. A similar situation existed in August last year, when the Bank expressed surprise in the market's negative reaction to its signal of higher interest rates given that the market was already pricing in higher rates than it was forecasting.
A January rate hike would also call into question the RBNZ's "new" approach. The Bank is supposedly focusing on the medium-term and is less concerned about short-term fluctuations in the currency. The RBNZ has also emphasised that with lower inflation expectations it is now able to tolerate somewhat greater variability in inflation in order to reduce variability in output. With interest rates already having moved up significantly, there would appear to be little to gain from a move in January. We think many investors would be confused by the move.
As a result, we think the investor reaction to a January rate hike would be negative. Both the currency and the bond market would be expected to sell off. Indeed, we would not be surprised if overall monetary conditions as measured by the MCI actually eased in reaction to the rate hike.
Notwithstanding our concerns about a January rate hike, we believe the RBNZ will eventually be forced to push interest rates much higher than it currently sees as necessary. For this reason our "opposition" to a January rate hike might seem counter-intuitive. However, we think it important for the smooth functioning of monetary policy that the Bank's actions are well thought out, supported by a full review of the inflation outlook and clearly signalled. We don't think a rate rise on 19 January will meet these criteria.
David Plank, Auckland
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