Monetary Policy Statement Preview - For March 15
Monetary Policy Statement Preview
Data Flash (New Zealand) - Preview
NZ: Monetary Policy Statement Preview (released 15 March 2000)
The RBNZ is expected to - raise the cash rate by 50 bps to 5.75% (risk distribution: a 75bps move is far more likely than 25 bps); - project the 90-day rate rising to 7.3% over next year (compared to 6.6% assumed previously).
Such a 90-day rate track would be consistent with an overall rise in the cash rate of 200 bps by March 2001.
The RBNZ is likely to justify the aggressive tightening profile with - a significant rise in medium-term inflation pressure (resulting from rapidly rising rates of domestic capacity utilisation and a further upward revision to the international growth outlook); and - a relatively weaker TWI contribution to the overall tightening process than previously projected.
Despite the more aggressive interest rate profile, the expected assumption of only a gradual appreciation of the NZ TWI from a relatively low starting point implies a weaker MCI track than published previously.
As a result, the RBNZ is likely to project inflation to rise sharply and stay above 2% over a two-year period. We expect the RBNZ's CPI forecast to peak around 2.5% late this year.
The fact that an extra year will be added to its forecast horizon will allow the RBNZ to show inflation falling back below 2% at the end of the forecast period. The Bank is likely to interpret the comparatively high inflation profile in the light of the step adjustment of the NZD that has occurred in response to the high current account deficit.
In terms of the risk analysis, the RBNZ is expected to comment on - the challenge arising from trying to contain potential second- round effects arising from the prolonged period of inflation above 2%; and - the conditionality of the interest track on the recovery of the NZD.
In summary, a 50 bps tightening, a projected steep interest rate track with potential upside risks, and a bearish inflation outlook, are expected to combine to a fairly hawkish RBNZ statement. The wording may be relatively strong as the RBNZ tries to justify its aggressive stance in the light of the surprisingly benign Q4 CPI.
While the market is already pricing in more tightening than the RBNZ is expected to project, we see a considerable risk of an adverse reaction to a potentially more bearish-than-expected inflation outlook and tone of the statement. Short- to mid-bonds are particularly vulnerable.
The NZD reaction to the Statement will depend on its credibility. We expect the confirmation of an aggressive tightening profile to provide support. However, there is a risk of the opposite effect occurring if the tone of the Statement is excessively hawkish, thereby leading currency markets to factor in the risk of an economic downturn as a result of RBNZ policy.
Revised Inflation Outlook
The RBNZ is expected to argue that the surprisingly low December quarter CPI was largely driven by one-off factors, with the reversal of some of those influences leading to a relatively high Q1/2000 CPI of 0.8% or 0.9% qoq. That would correspond to an annual inflation rate of 1.9% or 2.0% for the year to March.
Furthermore, a range of medium-term indicators suggest a significant rise in inflation pressure. Key influences are significantly higher- than-expected levels of capacity utilisation and the weak TWI performance.
The table below sets out likely changes to inflation projections.
Contributions to Inflation Forecast Revision
years to March; a% 2001 2002 2003
Output Gap 0.2 0.3 --
Unit labour costs 0.2 0.1 --
World Prices 0.2 -0.1 --
TWI 0.3 0.3 --
Housing -0.1 -0.1 --
Total change 0.8 0.5 --
November projection 1.7 1.6 --
Expected CPI track 2.5 2.1 1.6 Source: DB Global Markets Research
Growth Profile and Output Gap
September quarter GDP growth of 2.3% was 1.0% higher than RBNZ expectations. Indicators point to a somewhat stronger-than-expected December quarter as well (1.2% vs. 0.9%). On the other hand, the March quarter could turn out a little weaker than the Bank's forecast of 0.9%.
Overall, the level of activity at the end of the March quarter is likely to be around 1% above what was built into the RBNZ November projections. The Bank is likely to assume that around one third of that has been reflected in a higher growth rate for potential output over that period, which suggests that the output gap at the beginning of the forecast period is around 0.6% smaller than had previously been assumed. That is consistent with the significant rise in the QSBO's capacity utilisation measure.
Starting from a higher level of activity, we expect the RBNZ to leave its medium-term growth outlook of around 4% over the next two years broadly unchanged - with a slowdown to around 3% expected for the new forecast year 2002/03. Small upward revisions to the growth profile for the next two years - consistent with the somewhat lower MCI track as a result of the weak NZD - would likely be offset by similar revisions to the potential growth profile.
In summary, the RBNZ's output gap track is expected to be shifted symmetrically upward by 0.6% as a result of the starting point effect - which adds about 0.2-0.3% per year to the inflation outlook.
Unit Labour Costs
Latest trends in average hourly earnings have been below RBNZ expectations, due to significant compositional changes in the labour force. That effect distorts the underlying rate of wage inflation, which appears to be running at around 2.5% p.a. That is stronger than RBNZ expectations and consistent with a tighter-than-expected labour market. However, with the headline figure for hourly earnings having been consistent with its forecast, the RBNZ may decide to leave the wage track unchanged at this stage and refer to potential upside risks instead.
Latest productivity trends have been somewhat weaker than expected (around 1.0% p.a. compared to 1.5%). That also raises questions about the projected acceleration in productivity growth to 2.6% next year. As a result, we expect a modest downward revision to the productivity assumption.
Export prices have been running significantly ahead of forecast in the September quarter. Part of that is consistent with a stronger world growth outlook that has emerged since October/November. According to Consensus forecasts, trading partner growth for 2000 will be 3.6%, which compares to the previous forecast of 3.1%. However, we expect the RBNZ to assume a timing influence on price trends as well, which implies a slight reduction in the RBNZ's medium- term export price forecasts.
A similar argument applies to the track for world import prices, where the upward deviation has largely been due to oil prices - with a partial unwinding of that effect likely to be included by the RBNZ in the outlook for the next year.
The TWI has been trading significantly below the average level assumed by the RBNZ for the first half of this year (range of 53.5- 54.0 versus 56.5). We expect the Bank to apply a lower starting point for H1/2000 of around 54.7 and then assume similar annual rates of appreciation as in the previous forecast - which suggests a downward level shift in the TWI track of around 3%. The RBNZ is likely to spread the associated inflation effect over the next few years.
Consistent with a somewhat weaker-than-expected housing market, the RBNZ is expected to make small downward revisions to the assumed outlook for construction costs and rentals.
In summary, despite the more aggressive interest rate profile likely to be included in the RBNZ forecasts, a significant upward revision to the medium-term inflation outlook should be expected - with a peak of 2.5% or slightly above in late 2000.
Ulf Schoefisch, Chief Economist,
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