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RBNZ Observer: Another 25bp hike expected next week

RBNZ Observer: Another 25bp hike expected next week

New Zealand’s economy remains on track to post one of the strongest growth rates in the OECD in 2014
With demand continuing to pick up strongly, we expect the RBNZ to raise rates further next week
The recent fall in dairy prices and the high NZD may see the RBNZ hike by less than current market pricing implies over the next year

New Zealand’s boom continues
The RBNZ became the first developed world central bank to hike rates this cycle, in March, raising its cash rate by 25bp to 2.75%. We expect the RBNZ to follow through with a further 25bp rate hike next week, as New Zealand’s economy remains on track to post one of the strongest growth rates in the OECD in 2014.

A number of factors are supporting growth. Post-earthquake reconstruction continues to ramp up. Export commodity prices have risen strongly. New Zealand’s housing market is also continuing to strengthen, with prices rising further in January and February, after moderating in previous months. With inward migration at 10-year highs, the housing market is likely to strengthen more. Strength in house prices is also supporting household spending, with construction activity rising outside of post-earthquake rebuild-driven construction in Canterbury. Further to this, a combination of rising asset prices and an improving labour market has helped support a rise in consumer spending and confidence.

As a result, business confidence remains close to 20-year highs and business surveys present some upside risk to the RBNZ’s growth forecasts. At the same time, domestic cost pressures are continuing to pick up. As a result, the RBNZ is likely to continue to raise interest rates to manage the boom in demand and keep inflation in check.

However, a couple of factors could limit the extent of further rate hikes this year. The first is the recent fall in dairy prices. Dairy prices have fallen 25% since their April 2013 peak – with this fall likely a little quicker than the RBNZ was expecting. In addition, the NZD has continued to strengthen, sitting 2.5% above the RBNZ’s expectations so far in Q2. This should help contain cost pressures created by the boom in demand.

Overall, we see a hike of 25bps to 3.00% next week as highly likely. But we expect the cash rate to end this year at 3.50%, compared to the RBNZ’s implied projection of 3.75% as a high NZD may do more of the work than the RBNZ is currently assuming.

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