RBNZ set to leave OCR at 3.50% on Thursday, but there's still plenty of interest in what it says and what it forecasts

By Gareth Vaughan

The Reserve Bank leaving the Official Cash Rate (OCR) unchanged at 3.50% on Thursday morning shapes as the safest bet in town this week.

Off the back of the Reserve Bank's "period of assessment" rhetoric after its last OCR hike on July 24, and coming just nine days before the September 20 General Election, it appears a lay down misere that the OCR will be left unchanged. Or as Westpac chief economist Dominick Stephens puts it; "Next week’s September Monetary Policy Statement (is) a dead rubber - the OCR will be left unchanged at 3.5%, end of story."

Nonetheless there'll still be plenty of interest in the central bank's reasoning, its full Monetary Policy Statement, and in how Governor Graeme Wheeler and his team answer questions at their media briefing on issues such as the housing market, the international economic picture, bank mortgage rates, dairy prices, the New Zealand dollar, their inflation outlook, and of course, the election.

At the Reserve Bank's last OCR review, on July 24, the OCR was increased 25 basis points to 3.50%, meaning it has been hiked four times this year by a total of 100 basis points. However, the Reserve Bank signalled a "period of assessment" indicating a pause before any further increases. After Thursday, the next OCR reviews are scheduled for October 30 and December 11 this year, then January 29, March 12, April 30 and June 11 next year.

Last month the New Zealand Institute of Economic Research suggested the Reserve Bank should delay any further OCR increases until 2016.

Below are comments from a range of economists on their expectations for the OCR review, plus links to their full reports.

Here's HSBC chief economist Paul Bloxham

The rate hikes are over for now. With 100bps of interest rate hikes delivered between March and July, the RBNZ made it clear at the last meeting that it is on hold for the time being. And recent activity indicators suggest that some of the shine has been taken off the economy’s boom – meaning an extended pause from the RBNZ looks prudent.

With a no-change decision widely anticipated, more interest will be focused on the tone of the Monetary Policy Statement and the accompanying forecasts. Over the past few months, prices for key export commodities have continued to decline, impacting incomes. At the same time, business and consumer sentiment have softened, as has the housing market – all suggesting that higher interest rates are already restraining activity.

While the RBNZ’s forecasts may be a little softer that those published in June, they will almost certainly be more hawkish than current market pricing. In June, the RBNZ’s forecasts implied an OCR of around 4.5% at end-2015, whereas market pricing has now fallen to imply an OCR of only around 3.75% by that point.

We remain optimistic about New Zealand’s growth prospects. Even though indicators have moderated a little recently, they remain at healthy levels overall and we still expect the economy to grow by +3.5% over 2014 and +3.0% over 2015. With growth continuing to exceed potential, the economy’s spare capacity will likely diminish further and more inflationary pressure is expected to be generated.

The key judgment for the RBNZ is just how much inflation will be generated and when. So far, despite strong economic growth, inflation has been well-contained. The same is true of wages and forward-looking indicators of firms’ pricing intentions. With the inflation outlook still benign, the RBNZ has time on its side.

We now expect it to remain on hold for the rest of 2014, before resuming a hiking stance in early 2015. Despite the New Zealand economy’s strong performance over the past year or so, inflation remains well-contained, at +1.6% year-on-year in the second quarter. The risk of a sharp pick-up in the near future looks low, given the strong NZ dollar, soft wage growth and business pricing intentions that are certainly not high by historical standards. So far, New Zealand’s economy has perhaps exhibited more spare capacity than expected.

But with growth set to continue outpacing potential over the next couple of years, we do expect inflation will rise over time. For that reason, we believe the tightening cycle is not over but rather on hold. The OCR is still well below neutral – estimated to be around 4.5% – and will most likely need to be lifted towards that level next year and into 2016 as the economy tightens further. We now expect the next rate hike to be in the first quarter of 2015 (previously fourth quarter 2014), with the cash rate expected to get to 4.25% by end-2015 (previously 4.50%).

Here's HSBC's full preview report.

Here's ASB's economists led by chief economist Nick Tuffley

We expect the September MPS to imply the RBNZ will remain on hold until early 2015.

RBNZ’s interest rate outlook likely to be revised down around 30bp for mid-2017.

More tough talk on the NZ dollar likely after July’s “unjustified” and “potential for significant fall” comments.

The RBNZ’s language and forecasts in its September Monetary Policy Statement should reinforce our and market views that the RBNZ is most likely to remain on hold until 2015.

All up, developments have lessened the need for further interest rate increases. Dairy prices have continued to fall and the NZ dollar, though in line with the RBNZ’s June outlook, has still barely responded to the substantial year-to-date price falls. Confidence surveys reinforce that economic growth will inevitably moderate. House prices appear well contained, though net migration inflows have run ahead of RBNZ assumptions.

The RBNZ’s tune has changed since the June Monetary Policy Statement when it give markets a metaphorical clip around the ears for driving term interest rates too low for its liking. Although we don’t expect the RBNZ’s growth and inflation forecasts to change much, we do expect the RBNZ will forecast lower interest rates than it did in June to get those outcomes.

The extent to which the RBNZ revises down its 90-day bank bill forecast and length of any short-term pause will influence interest rates on the day. We expect a 30bp reduction to 5% for mid-2017 and a 3.8% rate for December 2014, outcomes that are likely to satiate markets. Market pricing is actually better aligned with drop of around 50bp in the RBNZ’s forecasts, so a downward revision of ‘only’ 20bp or less could even see a modest lift in interest rates on the day. The RBNZ is also less tolerant of the NZ dollar’s stubborn strength, so be prepared for further pointed comments about the NZ dollar’s still-high level. We expect the RBNZ to remain on hold until March 2015.

The balance of risks is slightly towards an earlier start through scenarios such as a marked drop in the NZ dollar or a very sharp rebound in dairy prices. The outcome of the looming election will be another factor to take into account, with recent political developments making the outcome appear finely balanced.

This MPS is likely to be the first since September 2013 in which the RBNZ hasn't had to revise up its forecast for the NZ dollar Trade Weighted Index. It is even possible the RBNZ shaves the forecasts back a fraction but any changes should be modest. The NZ dollar has softened through a combination of RBNZ warnings, markets responding a little more to weakening dairy prices, and through the US dollar itself also looking a touch stronger.

There are also strong rumours the RBNZ has been active in the forex market. Perhaps the RBNZ has taken the view that rather than revise up its NZ dollar outlook again it will make the NZ dollar come down to its outlook?! Light will be cast on that issue with the RBNZ's August forex reserves figures, for publication on September 29.

Once again the RBNZ is likely to revise up its working-age migration outlook, by around 4,000.

Annual net migration in the year to July hit the annual total the RBNZ expected for the year to December, and if anything momentum has picked up recently. Though a stronger migration outlook would imply greater demand, there has been some evidence that the boost to labour supply has been quick in coming through.

House price growth continues to slow, and the nationwide REINZ stratified price index has actually edged down very slightly in the 3 months to July. In contrast, house sales have started to edge up recently after steady decline in the wake of the LVR restrictions.

Despite that harbinger of stabilisation, we expect the RBNZ will be comfortable with housing developments from both inflation and macro-stability angles. There is scope for the RBNZ to revise down its house price outlook slightly, despite migration’s strength Likely RBNZ forecast changes

We expect the RBNZ’s forecasts to show:

- A similar growth outlook to that of the June MPS (3.5% for March 2015, 2.3% for March 2016), though 2014 second quarter revised down from 0.9% quarter-on-quarter.

- Lower near-term inflation, but the medium-term outlook remaining very near 2%.

- The NZD similar to (possibly fractionally lower) than the June MPS forecast track.

- The 90-day interest rate forecast around 30bp lower to 5% at mid-2017.

Here's ASB's full preview.

Here's Westpac's chief economist Dominick Stephens

The OCR will be left unchanged at 3.5% next week.

• Given the looming election, the RBNZ may opt for a low profile in its communications. Now is not the time to put a stake in the ground.

• We expect the RBNZ to signal that the OCR will remain on “pause”, thus ruling out an October hike.

• But the RBNZ will also reiterate its overarching expectation that the OCR will rise substantially over the coming years.

• Markets may be surprised when the forecast of 90-day interest rates doesn’t move much. We expect interest rates to rise a little on the day.

• The New Zealand dollar reaction to the MPS is more uncertain, depending on the RBNZ’s choice of words regarding the exchange rate.

• We expect the next OCR hike will occur in January 2015.

Economic growth, inflation and dairy prices are all lower than expected. But net immigration has snowballed unexpectedly, fixed mortgage rates are falling, and the exchange rate has dropped. It is not entirely clear which of these developments dominates so far as the medium-term inflation outlook is concerned. That said, now is not the time for the RBNZ to push the point. We doubt that the RBNZ will go out of its way to “correct” errant market pricing, the way it did in June.

The Monetary Policy Statement falls only nine days before a general election – any forecast issued now could well be rendered obsolete by the election outcome. At this juncture firm commitments and bold forecasts are best avoided in favour of a softly-softly approach. The best course available to the RBNZ is to “kick the can down the road” until the election has passed. The RBNZ can tackle the market head-on in December, if the data still warrants.

We expect the RBNZ’s press release will repeat the July comment that it “is prudent that there now be a period of assessment….” This would effectively rule out a October hike, and would cast doubt upon a December hike. But the statement will probably also reiterate the broad themes that the RBNZ has promulgated all year, including its expectation that the OCR will rise to a more normal level over the years ahead. The overall tone of the press release may fall somewhere between the June press release (which sounded very keen to raise the OCR) and the July press release (which was more contrite).

Net immigration continues to surge, and on our forecasts will reach an all-time high of 50,000 people per annum early next year. The most recent surprise has been extra arrivals coming into the country, rather than fewer departures (inflation is most sensitive to arrivals). The June MPS contained an alternative scenario in which net immigration rose by an extra 4,000 people per quarter. The recent surprise has been almost, but not quite, of that magnitude. In the scenario, the OCR had to rise by an extra 55 basis points over two years.

Fixed mortgage rates have fallen recently, and mortgage borrowers are taking the opportunity to fix their interest rates (a wise move, in our opinion). The average advertised two-year mortgage rate is now nine basis points lower than it was on the eve of the first OCR hike. Of course, lower fixed mortgage rates risks reigniting the housing market. Our assessment is that the negatives and positives in this list roughly offset one another. The outlook for medium-term inflation is lower than it was back in June, but is higher than it was in July.

There is, of course, scope for the RBNZ to come to a different judgement than we have. But it seems extremely unlikely that the RBNZ would come close to the view encapsulated by current interest rate market pricing. A Monetary Policy Statement along the lines we expect would surprise financial markets.

However, if the RBNZ does take a softly-softly approach to its rhetoric, then the scope for interest rates to rise on the day will be limited – especially with an uncertain election looming the near future. We think the most likely market reaction is a small rise in swap rates on the day. The likely exchange rate reaction is more uncertain.

Normally, the exchange rate would move in the same direction as interest rates, and a good argument can be mounted to suggest that the currency will rise on this occasion also. But there is a good chance that the RBNZ will use codewords for currency intervention in the press release, such as “unjustified” (even though the exchange rate has fallen, the RBNZ will still regard it as too high). Depending on the intensity of such language the currency reaction could differ to the interest rate reaction, up to and including the possibility of the exchange rate falling on the day.

Here's Westpac's full preview.

Here's some comments from ANZ chief economist Cameron Bagrie

The risk profile surrounding the economy is far more symmetrical than it was 3 months ago. The outlook is now akin to the March 2013 MPS when there were clearly both "upside and downside risk to this outlook". The RBNZ may have alluded to this in the June MPS scenarios (falling dairy prices and strong migration covering both bases) but those scenarios now look decidedly more real.

It's not just the likes of a low dairy payout; the NZ dollar is lagging, the global scene is far more wobbly and some geopolitical aspects (Russian sanctions) have clear implications for soft commodities. You can argue till the cows come home (no pun intended) about whether it’s geopolitics, or expectations of QE (or something else) that is driving European bond yields lower, but the fact that German Bund yields stand at just 0.9% tells you a lot about the state of play there.

Pan- European growth ground to a halt in the second quarter, and inflation continues to fall, lifting real yields. Back home here, technically, house prices are starting to gravitate backwards (quarter on quarter). There are upside scenarios too, notably migration is pushing above the RBNZ’s projections.

However, the balance of risks has clearly shifted. Inflation has now been sub-2% since 2009 (after adjusting for the GST and energy price spike in 2011). While there are the obvious inflation risks north, persistent low inflation outcomes risks getting overly ingrained in pricing and inflation expectations setting behaviour and there are now some real question marks over the forward drivers of inflation.

We're not convinced a new paradigm has arrived so forward risks (the likes of migration) still need management, but certainly some influences (such as stronger productivity growth and credit growth below the rate of nominal GDP) are being understated as inflation suppressants.

The RBNZ should move to a very neutral policy stance in next week's Monetary Policy Statement albeit with a soft tightening bias behind the scenes. The interest rate projections will invariably project a rising trajectory, but that'll be nothing more than the central tendency and mean reverting tendency of any macroeconomic model. That'll display a soft tightening bias but nothing more than that. A more neutral stance may validate or end up with interest rates lower, but that’s appropriate. Some will have palpitations for fear of fuelling housing again.

However, financial stability risks courtesy of housing can be managed by prudential means if necessary. The outlook for the economy is no longer asymmetrical. Inflation is projected to be closer than the bottom of the policy band in the second-half of 2014 than the 2% mid-point target. There is greater uncertainty over the evolution of inflation in 2015. The RBNZ has an inflation target not a growth one. If the situation changes so too can the RBNZ’s view (and ours).

We’ve seen enough to alter ours and the previously flagged 100 basis points of rate hikes we had pencilled in for 2015 looks pie in the sky stuff. There are still some risks that point that way, but there are now pending risks that suggest the OCR might not move much at all. Something between the two seems most likely.

Here's ANZ's full dairy and RBNZ update.

And here's BNZ head of research Stephen Toplis

The RBNZ is in an awful position as it tries to disseminate two key messages which might appear, at face value, contradictory. Given recent economic developments, the RBNZ will need to signal that it is on hold for the foreseeable future until there are clear signs of building inflationary pressure. Yet, at the same time, it will want to maintain its view that the cash rate needs to move, eventually, back to neutral, which must be at least 100 basis points higher than where it is now.

Deliver a statement that is too dovish and it risks a rally in money market rates which might lead to much lower mortgage rates and excess stimulus for an already overvalued housing market that is far from its death throes. Come across too hawkish and you end up with a credibility issue, given the negative news that abounds, and a NZD reaction that exacerbates that negativity.

We thus believe the RBNZ will try to take the middle line in delaying its next rate hike into 2015 (or at least talk about the risk of such) while still publishing an interest rate track that shows the cash rate headed back to at least neutral (4.5%) by the end of the forecast period.

This moderated stance has its roots in the June Monetary Policy Statement in which the Bank produced the following statement.“The projection for inflationary pressures, and so how far and how quickly interest rates will need to move, depends on developments in several key economic drivers – in particular export prices, the exchange rate, net immigration, the housing market and construction. How households and businesses react to these drivers and to increases in interest rates, will also be important”.

Here's BNZ's full report.