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OCR raised to 5.25%, followed by Q4 CPI of 0.2%

Data Flash (New Zealand) OCR raised to 5.25%, followed by Q4 CPI of 0.2%

Key Points

The RBNZ announced a 25 bps rise in the official cash rate to 5.25%, citing strong domestic and world growth as the reason.

The RBNZ noted that the November Monetary Policy Statement had projected an ongoing series of rate rises, and that today's move should be seen in that context.

Despite having priced in a 25 bps move, the bill market sold off around 10bps after the announcement, while short bond yields rose 3-4 bps. The NZD firmed marginally.

The RBNZ made its decision without knowledge of the December quarter inflation data released two hours later, which came in at a surprisingly low 0.2% qoq (0.7% below the RBNZ forecast made in November).

The annual rate of inflation (RBNZ measure) rose from 1.1% to 1.3%. The official measure, which includes two quarters of the interest rate inclusive old regimen, rose by 0.5% on an annual basis.

Immediately following the CPI result, the NZD weakened from 0.5200 to 0.5170, while bill yields fell back by 5 bps and short bond rates reduced by 2 bps.

Treasurer Cullen showed concern about the accuracy of the RBNZ's inflation forecasts and stated that the Bank should not assume price pressure when the data was not supporting it.

Main downward contributions to the quarterly CPI results were: food prices (-0.4%, climatic influences), electricity prices (-1.5%), household appliances (-1.3%); phone calls (-1.8%) and international air travel (-0.3%).

Main increases in CPI components included construction costs (+0.6%), domestic air travel (+5.2%), new cars (+2.7%) and petrol (+6.3%).

The main surprises were the modest rise in the housing group (low rise in local authority rates), the fall in the household operations group (declining prices for electricity and appliances), and a relatively weak transport sector (low international airfares and the lack of price increases for used cars).

Tradeables inflation was +0.3 (+0.5% annual), while non-tradeables increased by 0.2% (2.1% annual).

Median inflation was +0.1% (+0.6% annual).

Our preliminary forecast for the Q1 CPI is 0.5-0.6%, lifting the annual rate to 1.6%.

CPI Components

(regimen weights in brackets)

:::::::::::::::::::::::::::::::::::q%:::::::::::::::a%

Food (18.2):::::::::::::::::::: -0.4:::::::::: -0.8

:::::Fruit/Vegetables:::::::::: -5.7:::::::::: -9.8

Housing (23.0):::::::::::::::::::: 0.3:::::::::: 0.9

:::::Rentals:::::::::::::::::::: 0.0:::::::::: -0.8

:::::Construction Costs:::::::::: 0.6:::::::::: -0.3

Household Operation (14.8)::::: -0.5:::::::::: -0.1

:::::Electricity::::::::::::::: -1.5:::::::::: 3.2

:::::

H'hold Appliances/Furnishings:::::-0.6:::::::::: 0.1

:::::Phone Calls::::::::::::::: -1.8:::::::::: -16.7

Apparel (3.7):::::::::::::::::::: 0.2:::::::::: 1.4

Transport (15.4)::::::::::::::: 2.1:::::::::: 4.6

:::::Air Travel::::::::::::::::::::0.8:::::::::: 2.6

:::::Used Cars:::::::::::::::::::: 0.2:::::::::: -6.3

Tobacco/Alcohol (9.3):::::::::: 0.2:::::::::: 1.4

Personal/Health Care (6.1)::::: 0.1:::::::::: 1.2

Recreation/Education (8.8)::::: 0.0:::::::::: 2.8

Credit Services (0.7):::::::::: -3.2:::::::::: -12.2

::::::::::::::::::::::::::::::::::::::::::::::::::

Total CPI (100.0)::::::::::::::: 0.2:::::::::::::::0.5

Source: DB Global Markets Research, Statistics NZ

Analytical Price Series

::::::::::::::::::::::::: q%::::::::::::::: a%

CPI:::::::::::::::::::: 0.2::::::::::::::: 0.5

Tradeables::::::::::::::: 0.3::::::::::::::: 0.5

Non-Tradeables:::::::::: 0.2::::::::::::::: 2.1

Weighted Median:::::::::: 0.1::::::::::::::: 0.6

Source: DB Global Markets Research, RBNZ

Analysis

The arguments for and against the cash rate increase were finely balanced. The move was certainly justified as a response to the strength of economic activity - even taking into account the surprisingly low CPI result. The low inflation performance over the second half of last year does not imply that inflation is not going to be an issue in New Zealand over the next eighteen months, with the domestic and world economies continuing to grow at high rates. It is certainly too early to argue that the new paradigm has arrived in New Zealand, given little evidence that trend productivity growth has improved. New Zealand is also not in the fortunate situation where share market wealth effects act as an apparent substitute for higher wage increases.

As far as monetary policy is concerned, the fact that the peak in annual inflation later this year is now likely to be around 2% - rather than 2.5% as projected earlier - does not suggest that the New Zealand economy can sustain monetary conditions near cyclical lows. Today's cash rate move was intended to further reduce the monetary policy stimulus in the system.

The arguments we had raised over recent weeks against a cash rate move today were concerned with a different set of issues: * the risk of a renewed increase in market volatility as a result of elevating the interim assessment dates to the same level as the MPS dates; and * possible adverse reputational consequences for the RBNZ as a result of moving rates without having knowledge of a possibly low CPI result.

The RBNZ obviously felt that the latter two arguments did not carry sufficient weight relative to the need for continuing to push interest rates closer to their appropriate level. It appears that the disappointing NZD performance since the beginning of the year was the key factor that convinced the Bank that action on the interest front was required earlier than otherwise. It shows how concerned the RBNZ is about the currency performance and that the broad MCI philosophy is still alive - justifiably so. Ultimately, the RBNZ's view on where overall monetary conditions should be in the medium term is a straight function of the assessment of inflation pressures. It is not valid to argue that New Zealand has not seen much of an exchange rate pass-through in recent years and the TWI should therefore receive a lower weight in the RBNZ's assessment. The lack of inflation as a result of the NZD depreciation since 1997 was due to declining world prices at the same time. Now world inflation is gradually strengthening again and the RBNZ is rightly concerned about a situation where the influence on import prices is not sufficiently offset by the pass-through of a rising exchange rate.

With the NZD already underperforming, the RBNZ's concern was probably heightened by the fact that Fed and RBA rate hikes in early February are a near certainty, which would have widened international interest differentials.

In summary, while the timing of the cash rate rise so close to the CPI release may have created a problem for the RBNZ in terms of reputation, the substance behind the arguments for the move is very strong.

Going forward, we still expect the NZ cash rate to be raised to 6.0% by mid-year. With today's CPI result having raised some questions about inflation pressures, we expect the RBNZ to be cautious and aim for only a 25 bps move on 15 March, although the risk is on the upside if TWI weakness persists.


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