RBNZ raises cash rate by 25 bps to 5.75%
Data Flash (New Zealand)
As widely expected, the RBNZ raised the Official Cash Rate (OCR) to 5.75% following the interim review of monetary policy settings.
However, the accompanying press statement (reproduced below) was significantly less hawkish on future interest rate developments than the May Monetary Policy Statement, which had projected short rates to rise to 7% by early next year. While the RBNZ noted that the momentum of the economy had been at least as strong as anticipated in May, the Bank referred to renewed global growth risks and stated that the rapid rise of the NZD would lower inflation pressure going forward and therefore reduce the extent to which interest rates would have to tighten over coming months.
Considering the extent of the NZD appreciation, Deutsche Bank interprets the RBNZ's comments as saying that the cash rate is unlikely to peak higher than 6.25%. The RBNZ August Monetary Policy Statement, which will include specific interest rate projections, will shed more light on the issue.
We also expect the RBNZ to project inflation to fall to around 1.5% over the next twelve months, following a peak of 2.7% in Q2/2002. While the relatively high inflation figure expected for Q2 (+1.0% qoq, to be released on 15 July) may look disturbing at face value, it includes rising petrol prices and excise taxes, but virtually none of the NZD appreciation. Therefore, the data is likely to be dismissed as not giving a good guide to future inflation trends. Notwithstanding the RBNZ's change of mind regarding the peak of the cash rate cycle, the recent pace of growth seems to have strengthened the RBNZ's determination to nevertheless get the OCR back to their estimate of the `neutral' level (i.e. 6.0%) relatively soon.
Consequently, we attach a 70% probability to another 25bps rate hike on 14 August. We expect domestic data over the next month to show that the New Zealand economy is gradually losing steam, making it likely that the RBNZ will not hike rates at its October meeting. The rate outlook beyond that will significantly depend on the global recovery profile. However, even with a relatively positive outlook, we do not expect the OCR to be raised above 6.25% during this cycle.
Market reaction and outlook
Longer dated bills rallied 3-8 points, while bond yields were marginally down (2 points short end - 1 point long end). The Kiwi rallied around 10 points. The market is still pricing a cash rate track that we consider too aggressive (see chart). We expect softer economic data over coming months and the explicit presentation of a lower interest rate track in the August Monetary Policy Statement to cause a re-pricing of the NZ curve and a modest contraction in international spreads.
A more significant contraction in the NZ/US spreads will depend on the timing of commencement of the US tightening cycle.
Ironically, the NZ tightening cycle will most likely be finished before the first Fed rate hike.
NZ bonds would be an excellent defensive trade in a US bear market (10 year spread has potential to contract by 80-100 bps from current levels), particularly with further NZD strength expected on the back of continued global USD weakness.
Full text of RBNZ statement
OCR increased to 5.75 per cent
The Reserve Bank of New Zealand today increased the Official Cash Rate from 5.5 per cent to 5.75 per cent, but also signaled that further increases were now rather less likely than was indicated in the Reserve Bank's May Monetary Policy Statement.
Reserve Bank Acting Governor Rod Carr commented: "Adjusting interest rates so that they no longer actively encourage accelerated spending makes sense, given that the momentum of the New Zealand economy seems at least as strong as anticipated in May. Retail sales are at near record growth rates, helped along by very robust immigration flows, a strong tourist inflow and export incomes, though they are declining, are still at historically very healthy levels. Given the weakness of the world economy, recent overall growth performance has been outstanding.
"Nonetheless, since May there has been a much sharper rise in the exchange rate than allowed for previously, which has had the effect of tightening monetary conditions. If the exchange rate appreciation is sustained, or goes further, some heat will be taken out of future inflation pressures, reducing the extent to which interest rates may need to rise in the months ahead.
"Working in the same direction, international news from equity markets in particular suggests that the US economic recovery has become more fragile, with implications for the global economy. Furthermore, there are promising signs that New Zealand's inflation will peak in the next two quarters a little lower than earlier expected. Both factors will reduce inflation pressures further out.
"The balance of these factors will be the focus of the Bank's next full review, due with the Monetary Policy Statement on 14 August," Dr Carr concluded.
Ulf Schoefisch, Chief Economist, New Zealand