Preview RBNZ Interim OCR Review
Data Flash (New Zealand) - Preview RBNZ Interim OCR Review
On 14 March, the RBNZ reduced its official cash rate (OCR) by 25bps to 6.25%, in a move described as a finely balanced decision, with clear risks involved both in reducing the OCR and in leaving it unchanged.
The decision was made just two days earlier, well after the formal economic projections set out in the accompanying Monetary Policy Statement (MPS) had been finalised. Those projections had anticipated rates remaining at around 6.5%.
In the week or so leading up to 14 March, a raft of negative global news, including the publication of negative GDP data in Australia, a further sell-off in US equity markets, and very negative commentary regarding Japan, convinced the Bank that an easing move was warranted. Thus, in effect, the Bank overrode its central economic projection and took a step (of uncertain size) towards a more negative global scenario depicted in the closing pages of the MPS. That scenario, in which world demand fell 1% below trend by early 2002, necessitated a decline in the OCR to around 5% over the next year or so.
However, the RBNZ emphasised that its decision to ease should be seen as an insurance premium against that risk that the world economy slowed more significantly than its forecasts had allowed, rather than necessarily the beginnings of a substantive easing cycle. Indeed, in the Bank's view, it was by no means inevitable that the reduction in the OCR in March would be quickly followed by further reductions.
The key question for the coming meeting is whether data released subsequent to 14 March will have convinced the Bank that a further easing move is warranted, either as an extension of the insurance policy taken in March, or perhaps as a first step in an expected easing cycle.
As discussed below, on balance, we think that the Bank will feel that the March cut has been well justified by subsequent events, and that a further 25bp `insurance' cut on 19 April will help to forestall an extension of the apparent moderation in business and consumer confidence in recent weeks.
The case for a 25bp cut on 19 April
The RBNZ's central projection was based on the February edition of Consensus Forecasts. However, as the Bank had anticipated when deciding to ease, the March edition (released after 14 March) revealed a downward revision to expectations for global growth in 2001. Average annual growth for the 14 countries captured in the RBNZ's trading partner index declined from 2.8% to 2.4%. However, average growth forecasts for 2002 were unchanged at 3.6%.
Negative economic data since the March edition was compiled suggests that a further downward revision can be expected when the April edition is released. Indeed, the most recent poll in The Economist points to a further 0.1pp downward revision to trading partner growth in 2001. In addition, for the first time this year, a 0.2-0.3pp downward revision to growth in 2002 also appears likely, due to significant downward revisions to growth in the US and Japan, and to a lesser extent, Euroland.
This suggests that the Bank's next economic projections will incorporate a less optimistic world growth track - perhaps half way towards the more pessimistic scenario discussed in the March MPS. As far as the domestic economy is concerned, data has tended to verify the Bank's view of economic activity in recent months. Q4 GDP, while slightly weaker than the market expected, was roughly in line with the RBNZ's view (allowing for the impact of revisions). Indicators suggest that further growth of around 0.6% qoq can be expected in Q2, just a touch weaker than the RBNZ expected.
Retail sales appear to have begun to lift in February and housing market indicators have improved (more so in the secondary market than in the new home building market). In addition, the number of job ads has remained at a high level (perhaps helped by the impact of skill shortages on the level of repeat advertising).
Up until very recently, both business and consumer confidence indicators had remained very robust. However, the most recent QSBO business survey showed a sharp fall in business confidence from +21 to -12 (in seasonally adjusted terms). Similarly, both the Colmar Brunton and TV3 surveys have pointed to a recent decline in consumer confidence (although the level of confidence remains well into positive territory).
The decline in confidence likely reflects a number of factors, including greater media attention given to the extent of economic weakening in many of New Zealand's trading partners, the reported onset of drought conditions in some parts of New Zealand and a renewed weakening in the NZD.
Importantly, QSBO indicators of actual activity remain much more robust than indicated by the confidence data. This suggests that economic weakness is more imagined than actual at this point. However, as the Reserve Bank of Australia concluded last week, there remains a significant risk that weak expectations become self-fulfilling, especially if consumer confidence declines further in reaction.
Whereas the plunge in business confidence last year was driven to some extent by businesses desire to send a message of discontent to the Government, the most recent fall (while moderate in comparison) is driven by more genuine concerns, and therefore more likely to impact on firms' behaviour.
The combined impact of the factors above is that RBNZ's forecast of 3Ÿ% growth between Q1 2001 and Q2 2002 may be difficult to achieve. Our own forecast is for growth of 2.6% over that period (close to our view of the economy's present potential rate but weaker than the Bank's assessment of 3%). Therefore, the Bank's estimate of the output gap is likely to imply an easing in medium-term inflation pressures over the period ahead compared to the projections contained in the March MPS.
The picture of declining inflation pressures was supported by the QSBO. The net proportion of respondents reporting an increase in selling prices over the past three months declined substantially from + 33 to +16 - the lowest level reported since Q4 1999. Similarly, the net proportion expecting to raise prices over the next three months fell from +34 to +13. Amongst retailers, the net proportion of retailers expecting to raise prices declined from +44 to +30 (and a peak of +55 in Q3 2000).
However, not all inflation indicators have eased. Externally driven price pressures - at least in the short-term - look to have intensified since the Bank's projections were finalised. The Q4 export and import price indexes were much stronger than the Bank expected, and the trade weighted exchange rate index sits at present some 4% below the level assumed to prevail on average over the first half of 2001 (and 6% below the average assumed for H2 2001).
This suggests some upside risk to the RBNZ's near-term inflation track, and thus greater risk of second round impacts on inflation expectations (moderated to some extent by the slightly weaker economic environment).
We think that the RBNZ will conclude that the March rate cut has been justified by subsequent events.
Looking ahead to 19 April, the market is pricing a full 25bps rate cut.
Similarly, at least 12 of 15 market economists polled by Dow Jones concur with the market's assessment (in contrast to the situation in March). Assuming that the CPI prints broadly in line with our expectation (+0.1% qoq), and that this week's important US data shows no major surprises, we would estimate an 80-85% probability of a 25bp rate cut on 19 April.
On balance, we think that the RBNZ will agree with the market's assessment and conclude that a further 25bp `insurance' rate cut on 19 April is now warranted, thus helping to forestall an extension of the apparent moderation in business and consumer confidence in recent weeks.
However, we think that the Bank will be anxious to avoid giving the impression that the market should be pricing any further cumulative easing than is currently reflected in the curve. Therefore, as in March, we expect that the accompanying policy statement will emphasise that sizeable risks remain to inflation, and that it remains far from inevitable that the latest easing will be followed quickly by further easing moves.
Likely market reaction
As noted, at present the market pricing a full 25bp cut on 19 April with a further 25bp cut expected on 16 May. Looking ahead to next week:
If the RBNZ cuts rates by 25bps and issues a fairly cautious statement as expected, we would expect little reaction from the interest rate market (although a small rally is possible, especially if the RBNZ eases despite an higher than expected CPI outcome on the previous day).
If the Bank chooses to leave rates unchanged in April, the market will move to price a greater chance of a 50bps cut at the 16 May meeting.
If the Bank cuts rates by 25bps and issues a dovish statement, the market will move to price a greater than 25bp easing in May and greater easing beyond, thus moving further towards the 5% endpoint identified in the more pessimistic scenario discussed in the March MPS.
Darren Gibbs, Senior Economist
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