Cash Rate: Both Upside and Downside Risks

Harbour Navigator
Both Upside and Downside Risks
31 January 2013

As expected, the RBNZ’s Official Cash Rate (OCR) was left unchanged at 2.50%.

However, what surprised many in the market was the “dovish” tone to their statement. Instead of another warning about the housing market, the RBNZ acknowledged that there are both upside and the downside risks to the NZ economy. [Harbour Research: “Thinking the Unthinkable: The Chance of an OCR Cut”, September 2012.]

For much of the past year, the RBNZ has been facing some very large offsetting forces on future inflation in New Zealand (Table 1). The Canterbury rebuild and Auckland housing shortage will be strong tail winds; but the economy also faces strong headwinds from an extremely elevated currency and big contraction in fiscal spending.

Up until now, the RBNZ has carefully avoided hinting that they could interest rates cuts, for fear of fuelling a housing market boom. That changed today. As well as an explicit reference to the downside risks to the economy, the statement contained an alternative interest rate scenario where the OCR was cut to 2.0% if the currency remains elevated. This was seen as a green light by financial markets, pushing the NZD around 1 cent lower to 81.60.

There was little mention of the use of macro-prudential tools to cool the housing market. However, that was a deliberate decision, given the RBNZ are in the middle of their formal consultation. We will hear more about these tools and how they will be used in April.

Today’s Monetary Policy Statement supports our view that the RBNZ are likely to be hold for 2013. We see a greater risk that a rise in interest rates is led by a gradual lift in global long-term bond yields as the global outlook continues to improve through 2013.

Table 1. Balancing NZ inflationary pressures

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