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RBNZ MPS Preview: Less Hawkish, More Balanced

This week's RBNZ monetary policy statement will show a some moderation in rhetoric


The RBNZ will leave the official cash rate (OCR) unchanged at 8.25% this week, and the commentary in the monetary policy statement is likely to soften to a more neutral stance. The RBNZ is likely to acknowledge the intensifying downside risks to growth from a faltering housing market and a severe drought which is savaging much of the dairy producing regions: we expect to see a downward revision to RBNZ house price expectations and new concerns over the drought's potential impact on the economy. Furthermore, domestic mortgage rates are on the rise, independent of RBNZ monetary policy, with New Zealand's major banks and non-bank financiers passing on higher costs of funding. The elevated currency may also get a mention this Thursday to the extent it could further inhibits exports (on top of reduced dairy production) and partially offsets some of the tradeables inflation hitting NZ shores.

As a result, JPMorgan believes that the probability of another tightening in this cycle has all but disappeared. That said, the deteriorating outlook for short- to medium-term inflation will keep the RBNZ on hold for the remainder of 2008. Inflation looks set to remain above the RBNZ's 1-3%oya target band in 2008 and into 2009 as commodity prices continue to rise, the second round impact of higher costs (through oil and food prices) come through, wages rise, and the Government continues to push up construction costs with increased spending. Inflation pressures are still present and paramount in the RBNZ's focus. The RBNZ is a very stringent inflation targeting central bank, and JPMorgan maintains the view that Governor Alan Bollard will keep the OCR unchanged at 8.25% for the foreseeable future. Furthermore, the fiscal policy largesse should cushion growth later in the year.

Housing worse than RBNZ forecast

Signs that the housing market will contract in 2008 (recording falling prices, activity and sentiment) are growing by the week, and the aspirations of most Kiwi's are shaking with the concept. It has long been JPMorgan's view that New Zealand's housing market will buckle under the weight of high and rising interest rates, and the reduction of net-permanent migration. The question now is just how far, and fast, will house prices and construction will fall.

According to the latest REINZ report, the market is falling into a black hole, and at a rate of knots. The REINZ's January report showed the median house price fell from NZ$345,000 to NZ$340,000, and is down NZ$12,000 from the recent peak in November. What is more worrisome for the housing market outlook, however, was the substantial drop in sales volumes and spike in the number of days to sell a property. The number of sales has dropped 31%oya and is now at the lowest level since January 2001 - before the housing boom began. The number of days to sell a property spiked to 49 days in January, up for 36 days in December, and points to a further decline in the median house price. The annual rate of house price appreciation has now dropped to just 4%oya.

The speed and size of the housing downturn has come in below RBNZ expectations, and will be reflected in this week's MPS. We expect a downwardly revised house price forecast to around -5% in 2008.

Drought scorches earth and darkens outlook

The drought was officially called by Environment Waikato three weeks ago, after eight weeks of severe weather (no rain and high temperatures), and was stated to be the worst on record (over 100 years). The drought is hitting NZ's powerhouse of agriculture - the Waikato region - the hardest and dairy production is down 27%oya in the region. The major problem is the lack of feed (feed prices have shot up from NZ$55 a bale of silage to over NZ$140, and there is a global shortage) which affects both dairy and meat industries. The meat industry will be hit the hardest as meat prices have already fallen on the back of Australia's severe drought, which induced culling (increased supply) and pushed prices lower. There is currently a three week waiting period in NZ to cull herds, and they need to be fed in the meantime with inflated feed prices.

The dairy industry, on the other hand, has currently lost around NZ$500 million in production (according to Fonterra - the worlds largest producer), but a record high dairy payout to farmers will cushion the blow. Farmers will simply dry out their herds earlier than hoped for, and production will disappoint. Dairy prices will continue to rise. That said, the government has set up a drought committee. The incumbent Labour party, which is lagging in opinion polls as the election nears, is itching to throw cash at the situation. The potential drags on growth from the drought deserves a mention from the RBNZ on Thursday.

ENDS

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