Roger J Kerr says he doubts recent economic developments will suddenly change the RBNZ’s official line of completely stable OCR interest rates over the next 12 months

By Roger J Kerr

The local moneymarkets are now pricing a 100% probability of a first 0.25% cut to the OCR and a 50% probability of a second 0.25% cut over the next 12 months.

Several bank economists have changed their forecasts from “no change” in the OCR over the next 12 months to now forecasting two 0.25% OCR cuts this year.

A number of recent economic developments appear to be behind this shifting market sentiment, namely:-

• The Reserve Bank of Australia cut their OCR to 2.00% and some economic commentators continue to think that whatever Australia does we should automatically follow.
• The last RBNZ OCR review statement stated the thresholds for an interest rate reduction. They were a slowdown in general demand across the economy, alongside prices and wages not increasing as much as the RBNZ currently expect. A marginally lower than forecast wages increase for the March quarter released last week has convinced some pundits that the RBNZ threshold is already being met.
• Lower global diary prices feeding into a lower than previously anticipated 2016 season milksolids payout for dairy farmers. Fonterra will be announcing their first 2016 season payout forecast later this month; it could be nearer to $5.00/kg.

I strongly doubt that these short-term changes will suddenly change the RBNZ’s official line of completely stable OCR interest rates over the next 12 months.

There is just too much happening in other parts of the economy for the threshold for cutting rates to be met.

No-one is predicting a sudden decline in retail, construction and services sectors in the economy, which combined are a large part of the economy.

There are plenty of differing views around the place on the future direction of wholemilk powder prices (WMP). My reading of that demand /supply equation is that WMP prices will bump along the bottom at US$2,300/MT for six months and then slowly improve back to the long-term average price of US$3,000/MT.

Petrol pump prices have rebounded upwards, rents are increasing, commodity prices are increasing and we have yet to see the increases in consumer goods prices from the lower NZD/USD exchange rate.

It is very difficult to see the RBNZ threshold of weaker price increases being fulfilled.

On the wages front, the very low official annual CPI is pulling general wage increases down. However, many of our manufacturing clients cite a continuing shortage of skilled and semi-skilled workers. They will eventually be forced to pay more to attract the staff they need.

Whilst the RBNZ’s next phase of macro-prudential controls on the banks may take some of the edge off the residential property market boom in Auckland, only interest rate increases can really rein that market in. Somewhat hard to see the RBNZ tightening credit conditions with the macro-prudential tools to control the rampant property market and at the same time cutting interest rates.

Monetary conditions have already substantially loosened over recent weeks with the Trade Weighted Index (TWI) of the NZ dollar reversing sharply by 4% from 80.00 to 76.70. The RBNZ will be happy and more comfortable that the market itself has corrected the currency over-valuation at 80.0.

The interest rate yield curve has suddenly steepened in slope due to lower short-term interest rates locally and higher US Treasury Bond yields in the longer end. The interest rate yield curve could move to a lot steeper sloping yet as US long-term interest rates continue to pull our long-term rates higher (refer chart).

Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com