RBNZ Monetary Policy Statement
Data Flash (New Zealand)
Key points The RBNZ lowered the official cash rate by 25 bps to 6.25%.
The decision to ease was finely balanced and was not made until Monday. The preliminary decision made two weeks ago had been for no change in rates.
Concerns about the international environment, with an increased focus on weak Australian data, have led the RBNZ to undertake this `insurance easing'. Governor Brash noted that the domestic economy was still strong and that further rate cuts were `not inevitable'. However, Brash hinted at further rate cuts if the global economy deteriorated relative to RBNZ expectations. The RBNZ based its assessment of the international economy on February Consensus forecasts (see table below), but assumed a further downward revision to those forecasts over coming months.
A relatively subdued inflation projection underpinned the RBNZ decision. CPI inflation is projected to fall from currently 4.0% to 1.2% by the end of this, driven by the assumptions of an appreciating NZD and the unwinding of special factors that drove the sharp rise in the CPI in 2000 (e.g. world oil prices). Growth is forecast to track in line with potential of around 3%, thereby not putting extra pressure on capacity.
However, with the economy already close to full capacity, the RBNZ notes the risk that inflation outcomes could be higher than projected. In terms of the policy decision, that risk was outweighed by concerns about a further deterioration in the global trading environment.
Bill futures rallied around 10 bps, while long yields fell 3 bps after the Statement. The NZD firmed 10 bps.
Our assessment While we did not expect the RBNZ to cut rates at this stage, we endorse the insurance easing in the light of the deterioration of the global economic environment. The risk-return trade-off associated with the RBNZ decision to cut rates appears positive. If the international outlook worsens further, the RBNZ can build on this cut. That would demonstrate that the Bank has learned from its 1998 mistake and has become more proactive. If, on the other hand, the global scene improves and becomes less of a drag on the domestic economy than expected, the 25 bps rate cut can easily be reversed. Given the great uncertainty surrounding all policy decision-making at the moment, such a reversal would easily be forgiven.
The market is pricing further cuts of, in total, 50 bps for the 19 April and 16 May rate reviews, implicitly expecting a significant further deterioration in the global outlook relative to RBNZ assumptions. We remain less certain of such a scenario. While international data is expected to remain weak and convincing evidence of a bottom in the V-shaped US cycle is unlikely to emerge in the near future, it is not clear whether the data will be sufficiently soft to offset re-emerging RBNZ concerns about developments on the domestic inflation front. The RBNZ is very vulnerable with respect to its short and medium-term inflation forecasts:
The Q1 CPI is forecast to fall by 0.1% qoq (with a -0.6% contribution from the reduction in State House rentals). In the light of recent food price data and general pass-through of import price pressure, such a number appears optimistic. We expect +0.2% qoq.
The 8.0% qoq increase in import prices in Q4 is also expected to affect the next few CPI quarters, with wholesalers' and retailers' expectations of a NZD rebound having been disappointed and cost increases now being passed through with a lag. The NZD is currently around 2% below the RBNZ assumption for H1/2001 underlying the RBNZ forecast.
Considering latest data, Q4 GDP is now expected to print around +1.0% qoq, twice what the RBNZ has estimated. That suggests that the output gap of -0.5% the RBNZ assumed as the starting point of their forecasts has shrunk to zero, implying, more pressure on capacity.
The RBNZ projection of a zero output gap for the outer forecast years is also questionable, given that it is based on growth in potential output of 3% p.a. With productivity growing at 1.5% and the labour force expanding at only 0.7% due to negative net migration, such a figure is increasingly difficult to substantiate.
Finally, with the unemployment rate assumed to stay around its 12 year low of 5Ÿ%, a peak in wage inflation of only 3.5% has to be considered optimistic, particularly with higher-than-projected CPI inflation threatening to put further downward pressure on real wage growth.
In summary, while global developments will be the key factor driving further RBNZ rate decisions, domestic data and their implication for the inflation outlook should not be underestimated. Therefore, a further rate cut in April - following stronger-than-expected GDP and CPI data - is by no means a foregone conclusion.
Ulf Schoefisch, Chief Economist, New Zealand, (64) 9 351 1375