Despite last week's surprisingly strong GDP figures, economists believe the Reserve Bank will stick to its 'dovish' view that the next move in interest rates could be down when it reviews the Official Cash Rate on Thursday

By David Hargreaves

The country's bank economists don't believe the Reserve Bank will have been deflected from the view that the next move in interest rates may be down - despite last week's GDP figures coming in way stronger than the market expected.

RBNZ Governor Adrian Orr turned very 'dovish' - in economists' parlance - in his last review of the Official Cash Rate, August's Monetary Policy statement, stating that interest rates would be lower for longer, and even outlining a scenario in which the OCR might - if the economy flagged - be dropped from the current 1.75% to as low as 0.75%. 

The market was very surprised by this strong mood shift from the RBNZ and wholesale interest rates fell and the New Zealand dollar dropped steeply in response, with the markets pricing in a good chance of a reduction in the OCR.

However, a portion of these moves were reversed last week as the very strong GDP figures suggested that the expectation of interest rate cuts may well not come to fruition.

Of course, the GDP figures, which were for as long ago as the June quarter, very much represent a historic perspective of how the New Zealand economy was travelling then. 

In terms of the immediate future we still need to find out if the slumping levels of business and now also consumer confidence will be translating to slower economic growth later this year and into next year. In this regard it's worth noting that the much-watched (certainly by economists) ANZ Business Outlook Survey is out on Wednesday, the day before the RBNZ releases it's latest OCR review.

For the record, nobody thinks there will be any change to the OCR, which has now been at 1.75% since November 2016, but Governor Orr's statement (which this time will be just a one-page statement, not accompanied by a Monetary Policy Statement) will be scrutinised for any change in his tone or his expectations. 

ASB's economists say that given the continued weakness in business confidence and the risk that growth underperforms over the second half of 2018, they believe the RBNZ "will play this one strategically".

"It will likely not place too much emphasis on the stronger starting point for domestic activity and continue to dangle a rate cut ‘carrot’ to market participants, helping to keep downward pressure on the NZD and provide continued support to the NZ economy during this crisis of confidence."

The ASB economists say, at face value, the recent falls in business confidence suggest material downside risk to the RBNZ’s growth forecasts in the second half of this year (which are for 0.8% growth in the third quarter and 0.7% in Q4).

"It’s possible that, as the RBNZ considers its near-term GDP forecasts for the upcoming OCR Review, the stronger Q2 outcome will be partially offset by downward revisions to the RBNZ forecasts for second half of 2018.

'Ongoing slide in business confidence'

"Given the ongoing slide in business confidence we see a non-negligible chance of a rate cut over the next year, but the threshold of such a move remains fairly high."

Kiwibank chief economist Jarrod Kerr and senior economist Jeremy Couchman say they expect that the RBNZ will "stick to the tone" of the August Monetary Policy Statement.

"The Bank is unlikely, in our opinion, to take any chances on inflation at the minute. Inflation has been too low for too long. Persistently weak business confidence still casts a shadow on future growth, and monetary policy is forward looking in nature. We expect the Bank will sit on its hands for some time to come and begin gradually hiking the OCR from May 2020." 

ANZ economists also say they expect that the RBNZ will retain a consistent message that the next move in the OCR could be “up or down” – leaving cuts firmly on the table.

"Markets are pricing in about a 30% chance of an OCR cut by August next year. We think the RBNZ will be broadly comfortable with this, and therefore will not be setting out to elicit a significant market reaction in either direction."

'OCR unchanged as far as the eye can see'

BNZ senior economist Craig Ebert says he thinks the RBNZ will mostly see, from the recent economic information, more justification to simply keep the OCR unchanged for as far as the eye can see.

"In this vein, the RBNZ is probably happy to have seen the market largely back off its odds of OCR easing on the 12-month horizon (especially after what the Bank might have thought was a strongly dovish interpretation of its August MPS). If the Bank were to change its language on Thursday, however, we think it would be in a less dovish/more hawkish direction." 

The Westpac economists say with GDP growth surprising to the upside of the RBNZ’s forecasts, the chance of an OCR cut in the near future seems distant. 

"However, the strong GDP figures do need a little context. Firstly, the June quarter result is a bit dated from a policy perspective - although the RBNZ is conscious of where the economy has been, they’re more focused on where we’re heading.

"Secondly, the RBNZ actually wants the economy to be growing at a solid pace. With lingering softness in imported inflation, the RBNZ needs the domestic economy to be firing on all cylinders to achieve its 2% target for overall inflation."

'Uncertainty on the tone'

The Westpac economists say while they expect an on-hold decision this week, and that the RBNZ will signal the OCR is set to remain at an expansionary level for a considerable time, there’s a bit more uncertainty regarding the tone of the policy statement.

"We expect it to be either neutral or dovish from a market point of view – we ascribe equal probabilities to either outcome. A neutral Statement would simply restate that the next move could be “up or down.” Alternatively, the RBNZ could plausibly adopt a “soft” easing bias, explicitly warning that if the economy fails to accelerate as expected, the OCR could fall.

"That would match RBNZ comments made in the media, and would be in the spirit of open and frank communication that the RBNZ has embraced. Our central expectation is that the OCR will remain on hold until mid-2020. However, we put the odds of an OCR cut over the coming year at one in three.

"The RBNZ still has lofty expectations for the economy – they are forecasting 3.5% annual GDP growth for 2019, compared to our forecast of 3.1%. The RBNZ is probably still in wait and see mode, and is wary of the possibility of softness in inflation or the labour market. Any false step from the data could still be met by an RBNZ OCR cut over the coming year."