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RBNZ Expected To Hike OCR 25bps to 5.25%

Data Flash (NZ) RBNZ Expected To Hike OCR 25bps to 5.25%

We have just published the following research.

Data Flash (New Zealand) RBNZ expected to hike OCR 25bps to 5.25%

(Announcement due at 9.00am NZT, 17 April)

Commentary

In its March Monetary Policy Statement (MPS), the RBNZ hiked the OCR by 25bps to 5% and signalled that, based on its economic projections, a further 100bps or so of tightening could be expected by year-end. As discussed in more detail below, we think that recent data have pointed to a local economy that, at least at present, is more buoyant than that envisaged when the Bank finalised its MPS projections. Meanwhile, pressures on headline inflation have also increased, reflecting a rise in oil prices, increased tax on petrol, and a number of other influences. As a result, in our view, the RBNZ remains well on track to deliver, as a minimum, the series of 25bp tightening moves signalled in its March MPS projections, taking the OCR to around 6.25% by year-end. At the time of writing, the market is fully priced for a 25bp hike next week, and we expect this to be delivered.

Could the Bank surprise again and deliver a 50bp rise next week? We think that this is unlikely. Even during the aggressive tightening phase in 1999, when the OCR was raised by 200bps in six months, the Bank chose to move in 25bps steps at the `interim' meetings. The larger 50bps moves were reserved for the full MPS meetings, when the Bank is better able to justify such action with updated economic projections and a detailed statement. With the next MPS meeting just four weeks away, we doubt that the Bank will wish to break this precedent at this point. Moreover, in the absence of a very high Q1 CPI, a 50bp tightening would be viewed as very aggressive and would be seen as inconsistent with the `move early and in small steps' philosophy which Dr Brash has stated repeatedly since his 20 March tightening (most recently this week in an interview with Dow Jones newswires). And there is little that the Bank can do sensibly to avert the near-term risk of headline inflation again breaching the top of the Bank's 0-3% range.

Could the Bank surprise again and deliver an unchanged cash rate? Global growth sentiment has come off the boil a little in recent weeks and most other central banks have been talking down rate hike expectations (December 2002 Eurodollars have rallied 45bps since 20 March). But with the domestic economy performing strongly, and with headline inflation likely to remain stubbornly high (with consequent upside risks to the core inflation rate), we cannot see how the Bank could justify refraining from following the tightening cycle that it signalled so clearly in the March MPS.

Looking ahead we continue to expect a 25bp hike at the next meeting in mid-May. However, if the data flow continues in the vein of recent week's, the prospect of a 50bps hike in May is very real (at present, the market is fully pricing a 50bp hike). The statement accompanying the next week's decision will be analysed closely for signs that the pace of tightening might be stepped up in May.

Data released since the RBNZ's March rate hike

While Q4 GDP was weaker than the RBNZ had forecast (0.6% qoq vs 1.0% forecast), early indications suggest that Q1 GDP will print substantially stronger than the RBNZ's forecast of 0.5% qoq. After this week's retail sales release, we have revised our Q1 growth forecast to 1.4% qoq. Respondents to the NZIER's QSBO survey also appear to expect strong growth in Q2. Domestic demand continues to be the key driver of growth. Retail spending has gathered pace, with the 1.8% mom surge reported in February pointing to volume growth of over 2% in Q1. While spending on plant and machinery investment looks to have declined by 10% qoq in Q1, that has to be seen in the context of the record high level in Q4, and probably reflects the delayed impact of decisions taken in the immediate aftermath of 11 September. Investment intentions have recovered over recent months.

The prospect of a substantial boom in construction activity has been boosted by a housing market has continued to strengthen. The number of house sales rose 12% mom in February, while a similar sized rise in dwellings consents was also recorded. In part this reflects the low level of interest rates and robust levels of consumer confidence.

The rise in net migrant inflows over the past 12 months has also been an important factor driving domestic demand, and the housing market in particular. Migrant inflows during January and February ran in excess of the 30,000 annual rate assumed by the Bank. Population growth has close to tripled over the past year, driving up demand for accommodation and durables in particular. The resulting upward pressure on house prices, and the perceived impact on household wealth, is helping to underpin growth in domestic demand more generally.

Prospects for the export sector - at least for the manufacturing and tourism sectors - have also improved. Although sentiment regarding global growth prospects has cooled a just a little over recent weeks reflecting, amongst other things, concerns about corporate earnings, the impact of rising oil prices on the global economic recovery, and a disappointing March US payrolls result, it remains more upbeat than when the Bank compiled its MPS projections. Trading partner growth forecasts were revised up in mid March and may well be revised up again when the April issue of Consensus Forecasts is released this weekend. Meanwhile, despite an unexpected decline in February, we think that tourism sector is getting back on track to record strong growth. Developments in the commodity sector have been more mixed, with the dairy sector again hit by lower world prices (reflecting increased EU subsidies) but some other sectors firming (eg wool and meat). Overall, world commodity prices appear to be tracking broadly in line with RBNZ projections. However, with the trade-weighted exchange rate currently outperforming the RBNZ's March expectations, and with the prospect of further significant gains over the next 12 months, we think the risks favour lower inflationary pressure (ex oil) from the external sector than the Bank assumed in March.

As far as inflation is concerned, although next week's Q1 CPI is expected to print a little lower than the RBNZ expected in March, this largely reflects the earlier than anticipated fall in fruit and vegetable prices after a weather-induced run-up late last year. Beyond Q1 the immediate outlook for headline inflation has in fact deteriorated, in large part reflecting the renewed rise in oil prices on the back of tension in the Middle East. If oil prices remain at around recent levels, we think there is some risk that headline inflation pops back above the top of the Bank's 0-3% inflation target in Q2. This will fuel the Bank's concerns about possible second round impacts on inflation expectations.

Darren Gibbs, Senior Economist

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