Outlook for NZ Monetary Policy Post - MPS
Data Flash (New Zealand)
NZ: The Outlook for NZ Monetary Policy Post - MPS
As widely expected - at least since the previous week's labour market data - the RBNZ left its Official Cash Rate (OCR) at 5.75%.
The accompanying Monetary Policy Statement (MPS) was, however, more hawkish than expected, causing the market to substantially re-evaluate the likelihood of further easing.
That re-evaluation has pushed the market towards our own central view - that the RBNZ's easing cycle concluded in May and that the next move will be a tightening.
However, we think that the near-term risk remains weighted towards further easing, rather than the early tightening that the market now seems to be contemplating.
This week the RBNZ decided to retain its Official Cash Rate (OCR) at 5.75%. Although the cash rate decision was largely anticipated, the tone of the accompanying Monetary Policy Statement (MPS) was more hawkish than the market had expected. While, as noted in last week's Dollar Bloc Weekly, we had expected some rebalancing of the RBNZ's forecasts and risk assessment in favour of our own more hawkish view, the extent of rebalancing proved a little greater than we had expected.
Given the relative buoyancy of the domestic economy, and the presence of the additional upside risks to inflation, the RBNZ indicated that it had no reason to date to regret the relatively cautious way that it had reduced rates. Indeed, the RBNZ went on to say that:
"...the current situation would point to an early increase in the official cash rate were it not for the risk that the international environment will turn out to be even weaker than assumed".
Market has concluded that easing cycle is over
The above statement, in particular, was the catalyst for a significant sell-off in the debt market, with the market removing any chance of further easing from the curve, and even flirting with the possibility of a pre-Xmas tightening.
We agree with the market's re-assessment that the RBNZ easing cycle concluded in May. Indeed, we've held this view since April. However, for a number of reasons, we think that the market has over-interpreted the `hawkishness' of the MPS and is getting ahead of itself in contemplating an early tightening.
Our view from here
We think that the following points are crucial to analysing the likely path of monetary policy from here:
The RBNZ remains concerned about the global economy. Indeed, the MPS contained a scenario that pointed to additional easing being necessary if the global slowdown proves much deeper and more prolonged than current consensus forecasts suggest - not our central view, but a significant possibility nonetheless.
That scenario is likely to remain plausible for a number of months yet. Data coming out of the European and Asian economies is expected to remain poor. And even if evidence emerges that the US economy is responding to the direct impact of tax cuts, it will be some months before one can be confident that the stimulus will be sustained into 2002.
We think that the RBNZ will wish to be very confident that a tightening is required before reversing this year's easing moves. An early tightening, subsequently reversed, would be very damaging to the RBNZ's credibility, undoing some of the modest gains in standing that its has achieved with its easing moves this year. Moreover, given that the RBNZ projects only a modest tightening cycle, there should be little urgency to raise rates. The chances of the RBNZ falling significantly behind the curve seem slight. However, should this occur, the RBNZ could easily catch up with a 50bps tightening or a couple of rapid-fire 25bp moves.
Aside from Q2 GDP, which we expect to print just a little stronger than the RBNZ's pick of 0.8% qoq, further information to potentially fuel the RBNZ's hawkish tendencies is unlikely to be released before mid-October, when the Q3 CPI and NZIER business survey are due. Additional labour market data, perhaps showing further evidence of a rise in wage inflation and providing some indication of the strength of the economy in Q3, is not due until early November.
The RBNZ's central projection assumed an average trade-weighted exchange rate (TWI) of 51 in H1 2002, rising to 54 in H2 2003. As a result of the recent appreciation, the NZD has already moved ahead marginally ahead of the RBNZ's H1 2002 assumption and the views of Deutsche Bank's FX strategy team imply that the RBNZ's H2 2003 target could be met by mid 2002, if not earlier.
Bearing in mind the above points, we conclude the following about the likely path of monetary policy:
The likelihood of a shift in the OCR at the 3 October interim review - either up or down - is low (20% or less). If there is to be a movement in October, an easing is significantly more likely than a tightening given the scheduled data flow.
The likelihood of a shift in the OCR at the 14 November MPS is somewhat higher, though less than 40%, and we think weighted mainly towards the possibility of further easing rather than an early tightening. Given our view of global developments, we doubt that the RBNZ will feel sufficiently confident to lead the tightening charge so early, even if the emerging inflation data remains a little worrying. On the other hand, further poor global data, benign CPI and labour cost outcomes, or a run-up in the NZD could see the OCR shifted down a further 25bps.
If the RBNZ does not ease further during 2001, this is probably because the global economy has not deteriorated significantly relative to the Bank's current projections. By early next year, our central view is that the global economy will be beginning to look a little more robust. This raises the real possibility of a rate hike at the January 2002 interim review - especially if the domestic economy has performed strongly over the Xmas period. However, this is not our central call, especially if the NZD is out-performing the RBNZ's expectations.
By the time of the March 2002 MPS, we expect the global and domestic climate to be uniformly conducive to an RBNZ rate hike, leading the RBNZ to raise the OCR by 25bps. We would not rule out a 50bps hike if the domestic economy is performing particularly strongly or, instead, a 25bp hike in both March and April, as a more sure-footed RBNZ seeks to achieve a tighter stance. The performance of the NZD will be crucial to the pace of tightening.
To summarise, we conclude that the view we took in April remains the best central view i.e. the RBNZ's easing cycle concluded in May and that the next move will most likely be a tightening, although probably not until Q1 2002. If there is to be a move this year, an easing seems more likely than a tightening.