Lack of inflation, higher kiwi suggest RBNZ rate cut

Lack of inflation, higher kiwi suggest RBNZ rate cut next week, may be low point of cycle

Dec. 4 (BusinessDesk) - The Reserve Bank will likely lower the official cash rate to 2.5 percent next week, and may signal the end of the current easing cycle, because inflation is weaker than expected, the kiwi dollar is higher, and the central bank envisaged one further reduction after it cut in September.

Governor Graeme Wheeler kept the benchmark interest rate at 2.75 percent at his Oct. 29 review, saying "some further reduction in the OCR seems likely" to ensure annual inflation returns to the mid point of its 1 percent-to-3 percent target range. Thirteen of 14 economists in a Reuters survey expect he will cut the OCR by a quarter point next week, then hold the rate unchanged until the first quarter of 2017, when he expected to raise the rate back to 2.75 percent.

Wheeler would reach his inflation target by the third quarter of 2016 based on the projections in the September monetary policy statement, but since then there are signs price pressures have fallen away and the trade-weighted index, at just under 72, is sitting about 6 percent above the 67.9 average level the bank assumed for the fourth quarter, reducing imported inflation. A cut next week would allow Wheeler to deliver a Christmas present to exporters, businesses and households, while no change could push interest rates and the kiwi higher.

"Given the benign outlook for domestic inflation, a desire to maintain downward pressure on the exchange rate and the bank’s likely assessment of the risk profile, we expect the RBNZ will retain an easing bias following the rate cut we expect next week," said Darren Gibbs, chief economist at Deutsche Bank, in his MPS preview.

Still, Gibbs said he expects "the RBNZ’s formal interest rate projection will imply no more than a chance of a further rate cut, contingent on the assumption that the exchange rate resumes a downward trend."

Economists expect inflation to undershoot the Reserve Bank's September MPS forecast of 0.2 percent for the final three months of 2015. Westpac Banking Corp forecasts a quarterly decline "closer to -0.2 percent" because of lower prices for petrol and food prices, and general weakness in retail prices.

"Some might be tempted to 'look through' inflation weakness emanating from the likes of food and petrol prices," said Westpac chief economist Dominick Stephens. "That would be a mistake – this is a continuation of the very global themes that caused New Zealand inflation to fall so low in the first place."

Wheeler will have to weigh up the risks of adding fuel to the housing market via lower borrowing costs, with overheated prices in Auckland already having a ripple effect on neighbouring regions from home buyers looking for somewhere affordable to live.

Prices of dairy products are higher than where they were at the time of the September MPS and whole milk powder gained 5.3 percent in this week's GlobalDairyTrade auction to US$2,260 a tonne, although it is still short of the US$3,000 a tonne Fonterra Cooperative Group has said is needed to support its current forecast for the 2015/16 season of $4.60 per kilogram of milk solids. Fonterra reviews that forecast next week. The ANZ Commodity Price Index slid 5.6 percent in November, led by dairy products after two months of gains.

Some readings of the New Zealand economy are more upbeat. Business confidence rose to a six-month high in November. The BNZ-BusinessNZ performance of manufacturing index was at 53.3, seasonally adjusted, in October, while the performance of services index was at 56.2. Both were above the 50 reading that separates expansion from contraction.

A net 14.5 percent of businesses were confident about the general outlook for the economy over the coming year, up from 10.5 percent last month, according to the ANZ Business Outlook survey.

Westpac's "Ready Reckoner" report, which assesses the likely impact on the Reserve Bank's 90-day interest rate forecast of various "shocks" or surprises that have hit the NZ economy since the last MPS, puts the net change at just 5 basis points (bps). The September MPS had the 90-day bank bill rate levelling out at 2.6 percent by September next year, from 2.91 percent currently. The biggest weighting in the Westpac analysis was given to the stronger TWI, seen shaving off 25 bps. That's offset by 20 bps of gain from higher house prices, 15 bps from higher export prices and 5 bps from migration. Near-term economic growth is counted as 5 bps.

The Reserve Bank will be making its interest rate call a week ahead of the key Federal Open Market Committee meeting, which is expected to result in the first increase in the federal funds rate since it was cut to between zero and 0.25 percent in December 2008 to support an economy reeling from the sub-prime mortgage crisis that precipitated the global financial crisis.

Fed chair Janet Yellen yesterday stoked expectations the bank will hike following its Dec. 15-16 meeting, citing an improving labour market and the outlook for inflation. The market will get the latest reading on employment in the US with the release this weekend on non-farm payrolls for November, which are forecast to show the world's largest economy stacked on 200,000 jobs last month.

"If the Fed does hike, the New Zealand dollar could be driven down, which would boost inflation in New Zealand," Westpac's Stephens said.

(BusinessDesk)

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