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Hiked again, but short pause now expected

Hiked again, but short pause now expected


RBNZ Observer Update: Hiked again, but short pause now expected


The RBNZ hiked its cash rate by another 25bp to 3.50%, as expected. As noted in the statement, the economy continues to grow at an above trend pace and, although inflation is low, for now, they expect domestically-produced inflation to pick-up. Today's move was another step in its plan to lift the cash rate back towards neutral. However, having delivered 100bp of hikes since March and with an election due in September, the RBNZ also noted that they now plan to pause for a 'period of assessment before interest rates adjust further towards a more-neutral level'. We expect them to be on hold for the next few months, but we still see another hike before year-end and the cash rate at 4.50% by end-2015.

Facts
- The RBNZ lifted its cash rate by 25bp for the fourth time this year to 3.50%, as expected (14 of 15 economists in the Bloomberg survey expected a hike, including HSBC).

- The key sentence in the statement was: 'it is prudent that there now be a period of assessment before interest rates adjust further towards a more-neutral level'.

Implications
New Zealand remains the exception amongst the developed world economies, with an aggressive monetary policy tightening already underway. The RBNZ has lifted its cash rate by 100bp since March, with the latest 25bp delivered today. New Zealand's growth is being driven by four key factors: the post-earthquake rebuild of the Canterbury region; strong dairy exports; strong inward migration; and, until recently, very low interest rates.

Growth is already well above trend and strong growth is expected to continue because most of these factors will support it for some time to come. We see New Zealand as likely to be the fastest growing OECD economy in 2014, with above trend growth to continue in 2015. Amongst the developed world economies we still see New Zealand as a 'rock star'.

However, having lifted interest rates by 100bp in the past five months and with an election due in September, the RBNZ has decided that it is now time to pause and assess the impact of the aggressive tightening they have already delivered. The low Q2 inflation print (1.6% y-o-y) helps to provide them with the luxury of a bit of time. The RBNZ sees this as a pause, rather than the peak of the cycle and we agree. Their statement noted that 'it is prudent that there now be a period of assessment before interest rates adjust further towards a more-neutral level'.

We expect them to be on hold for the next few months, although we still see another hike before year-end. Whether this happens in October, December or they remain on hold, in our view, very much depends on the Q3 CPI print, due on 23 October. Our central case sees a further hike in October, as we expect a strong CPI print. We still expect the cash rate to be 4.50% by end-2015.

The other factor providing the RBNZ with a bit more time is the very high NZD. The RBNZ continues to note that the high currency is 'unjustified and unsustainable' and that they expect it to fall, in line with the recent decline in dairy and timber prices. But, at a time when the major developed economies have policy rates close to zero, a significant fall in the NZD seems unlikely. With low global financial market volatility and a widening positive interest rate differential with rest of the world, New Zealand is an attractive destination in the 'search for yield'. Our FX team continues to expect a strong NZD.

Plus, to a large degree, the high NZD is actually helping the RBNZ. In an economy that is growing at a well above trend pace, the high currency is helping to keep inflation under control.


ends

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