Wholesale interest rates rise after RBNZ holds OCR (Update 4)

The Reserve Bank's decision to hold the OCR on Thursday and call on banks to cut their short term lending rates has been widely ignored by the banks and the markets in the first 24 hours after the announcement. If anything, the chances of increases in mortgage rates has risen because wholesale interest rates rose on Thursday after the OCR decision and the Reserve Bank's forecasts of an economy. Bank bill rates rose around 10 basis points and swaps rates rose between 9 and 25 basis points on Thursday. Here are comments below from economists about the Reserve Bank's (RBNZ) decision to hold the Official Cash Rate (OCR) at 2.50% on Thursday morning. (Update 4 includes Westpac comments.) Westpac's Brendan O'Donovan pointed to the rise in wholesale interest rates after the OCR announcement and said the Reserve Bank faced a difficult task trying to jawbone interest rates lower. ANZ National Senior Markets economist Khoon Goh said that the policy cycle looked as if it had troughed, bar an offshore trigger that may force the need for further cuts. ASB economist Jane Turner said they had pushed out their expected timing of further cuts in the OCR to a 25 basis point cut in both September and October, which would take the OCR to 2%. JP Morgan economist Helen Kevans said the timing of further moves was uncertain, but that "without a notable shift lower in shorter-term rates, or if doubts grow about the sustainability of recent signs of strength in the global economy, the RBNZ probably will choose to ease policy further." BNZ economist Craig Ebert said the BNZ thought the RBNZ "misjudged the impact today's MPS will have on the markets." Ebert pointed to a jump in wholesale rates that will put further upward pressure on retail interest rates.

Westpac's Brendan O'Donovan

The RBNZ's big fear, as spelled out in an alternative scenario in the MPS, is that the recovery manifests as a return to the imbalances that have plagued the economy in recent years: rising house prices driving an increase in household spending, while a stronger currency hammers the export sector (Fig 4). We think it's a valid concern, since little has happened during the credit crunch to alter the relative appeal of borrowing versus saving - and record low interest rates for the foreseeable future certainly wouldn't help. While the RBNZ didn't publish an interest rate forecast for this alternative scenario, we can take it from experience that they would be hiking rates earlier and faster, not cutting further, in this environment. Unfortunately for the RBNZ, the market seems to have decided that their very low interest rate projections strain credibility, and instead has latched on to the talk of recovery. The one-year swap rate has risen by 9 basis points, while two- to five-year rates have risen by 20-25 basis points. The RBNZ faces a difficult task in managing interest rate expectations at this point in the cycle, but we doubt that they would see any benefit in cutting rates again simply as an attempt to 'send a message' to the market. We expect the RBNZ to remain on hold again at the July OCR review. For now, we are maintaining our pick for further cuts later this year, reflecting our view that the global recovery still has some major hurdles to overcome: weak household balance sheets, vulnerable banking systems (particularly in Europe) and rising long-term interest rates. However, if the NZD moderates its gains, or global demand improves faster than expected, the RBNZ will be on hold from here.

ASB's Jane Turner:

The RBNZ acknowledge signs of so-called green shoots, noting international economic activity is stabilising and international financial conditions are improving. The RBNZ also noted the recovery in the housing market and net migration. Nonetheless, the RBNZ continued to emphasise the weak economic outlook and that risks remain weighted to the downside. Inflation pressures are lower then previously expected and CPI inflation is likely to briefly fall through the bottom of the target band later this year. While verbally the RBNZ maintained its easing bias, their 90 day forecast does not actually incorporate another cut. The RBNZ may think it has done enough for now and the threshold for further cuts is now higher. The Bank seems resigned to the fact the NZ dollar and longer-term rates are higher than would be ideal. The RBNZ expects that the TWI will continue to fall to 52 cents, and with the TWI currently at 59.70 we see this as unlikely. As a result, we believe the RBNZ is likely to face downside risks to their projections for growth and inflation and at some stage in the future is likely to want to ease monetary conditions further. We continue to see the risk of further rate cuts. However, we have pushed the timing of these cuts out with 25 basis point cuts in September and October, bringing the cash rate to 2.0%.

JP Morgan's Helen Kevans

The dovish statement accompanying the OCR announcement could have supported a decision to cut the cash rate. The Governor acknowledged signs of stabilisation in the global economy and improving conditions in international financial markets, but said the risks on balance to domestic activity remain skewed to the downside, the main reason being the expected strengthening of the NZ dollar. Indeed, recent NZD appreciation has contributed to a tightening of domestic monetary conditions, with the currency up 10% since the last OCR decision on April 30. Further NZD strength, forecast by the RBNZ, will hamper any export-led recovery at a time when global demand already is weak. ... Funding pressures have, however, eased, according to Dr. Bollard. One of the reasons we believed that a rate cut would be delivered today was that it may have prevented domestic banks from raising their mortgage rates, to compensate for elevated funding costs. The Deputy Governor recently highlighted the RBNZ's disappointment that some domestic banks had refrained from passing on cuts to the OCR, but the good news is that households refinancing their mortgages continue to move onto lower mortgage rates, a trend that will continue over the medium term. In our view, the statement accompanying the "˜no change' decision today left the door open to further policy easing, if deemed necessary. As in the April statement, the Governor made clear that the OCR will be kept "at or below the current level through until the latter part of 2010." There is scope for further policy easing "“ the terms of trade is falling, private consumption is weak, and inflation pressures have eased. In fact, the RBNZ expects headline inflation to fall below its target 1-3% range later this year. We believe that headline inflation will fall below target in 3Q09. But, the timing of the next move, if any, remains uncertain. It will take a material change in the global outlook or a significant tightening of domestic monetary conditions to trigger a further reduction the cash rate. Dr. Bollard acknowledged today that there is room for further reductions in shorter-term lending rates. Without a notable shift lower in shorter-term rates, or if doubts grow about the sustainability of recent signs of strength in the global economy, the RBNZ probably will choose to ease policy further.

ANZ National's Khoon Goh

While the RBNZ has left the door open for further cuts, lacking an offshore trigger, 2.5 percent looks to be the trough in the policy cycle. Absent a further material deterioration in economic prospects or a rise in systemic risks to the financial system, we believe this easing cycle is now over. This is despite the considerable wariness we have towards the NZ economy. However, facing a structural rebalancing process, there is simply some aspects to the economic cycle that policy cannot and should not respond to. Looking towards the potential normalisation in policy, we have pencilled in the start of the tightening cycle in late 2010, concurring with the elongated economic adjustment prognosis. There is an inevitability about what needs to happen for the NZ economy to rebalance, and it includes a weaker currency. However, the issue is really one of timing. The longer the adjustment is pushed out (via rejuvenated domestic demand, especially the housing market, and a stronger currency), the higher the potential for a more severe correction on the other side. We are siding with the RBNZ in viewing that recent tensions (and a rising currency) will not last long. However, for now, the market has taken the decision as NZD positive, gaining over 70pips against the USD and almost 100pips against the AUD. A lot of this looks to be position related and we expect global forces to dominate once again overnight. Swap yields sold off across the curve. While on the face of it this appears to be some cynicism towards the "lower for longer" message as yet, this looks to be more flow and expected mortgage related pay-side pressure.

BNZ's Craig Ebert

The thrust of the Bank's commentary was more in keeping with its 90-day bank bill forecasts, which flat-lined at 2.80% in yield. This flatly denied the further easing we thought this MPS might have projected for the near term, especially if Bollard held firm today. Yes, it was helpful that the Bank's projections implied the OCR staying at a 2.50% low right the way into the second half of next year. But that might get lost in the wash, with greater global forces now bearing upwards on mid to long NZ wholesale interest rates. Part of this, of course, relates to the huge demand governments around the world are now placing on the world's capital, as they struggle to fund the massive fiscal deficits that are so important for averting a deeper global recession and deflation. In this respect, we suspect the Bank has misjudged the impact today's MPS will have on the markets. It's not as though its messages were unreasonable. But monetary policy never works in a vacuum. The Bank looked to be heeding this back in March, when its emphasis on slowing down the easing cycle was important in stopping the markets galloping too far down easy street. But today's MPS would seem to have dropped the ball, in that it risks egging on the recovery-trade movements in NZ rates and the currency that were bound to happen to some extent anyway. We need only look at today's market reaction to get an inkling of this. Key wholesale rates have jumped by more than was consistent with removing the slight chances attributed to a 25bp rate cut today. The 1-year swap rate has increased 10bps, but the 2-year is up about 20bps in yield. These will put upward pressure on retail interest rates, at a time when assessing appropriate margins remains as complex as it's been for ages. But our broader concern is with the currency. It has already reacted "favourably" to the on-hold-with-recovery-on-top story the June MPS emphasised. Kiwi has put on more than half a cent, as has NZD/AUD. ... (W)e've decided to take the June MPS at its word and run with the 2.50% OCR base it projects into 2010. But that's not to completely abandon the downside risk to the cash rate we previously saw by the end of the year. We believe it's something to keep very firmly in mind, albeit now as a strong risk rather than something we have in our central track.