Economists split on timing of first OCR hike - end of 2011 or first quarter of 2012? Depends on quake rebuild, underlying inflation pressure

Economists at New Zealand's major banks are split on when the Reserve Bank might begin to increase the Official Cash Rate from its emergency setting of 2.5%, pointing to either late 2011 or the first quarter of 2012.

The Reserve Bank indicated in its March Monetary Policy Statement it would begin to raise the OCR when inflationary pressures began to flow through the economy from the rebuilding of Christchurch, which was been interpreted as the begining of 2012.

All economists are however confident the central bank will keep the rate on hold at 2.5% at its next review this Thursday, to be announced at 9am. The Reserve Bank's accompanying statement on Thursday will be closely scrutinised for clues on when it sees inflationary pressures starting to show through, with some economist saying these will be too great to ignore before the year is out.

Figures released by Statistics New Zealand last week showed annual inflation in the year to the March quarter was 4.5% - half of which was put down to the increase in GST on October 1 from 12.5% to 15%. The RBNZ has said it would look through the impact of the GST increase in terms of monetary policy - it is tasked with keeping medium-term inflation in a band of 1-3%.

What they are saying:

BNZ economists said the pressure to hike the OCR would be too much for the Reserve Bank to ignore by late 2011:

So along with the earthquake’s impacts expect greater acknowledgement of the generational terms of trade boom New Zealand is experiencing, and even a word on inflation this time. To be sure, the Q1 CPI was neither here nor there for policy deliberations, but it’s the outlook we remain worried about.

However, that’s not to say the RBNZ can this Thursday sound sure on the economy and its likely path. It’s far too early for that. And so on the cash rate we suspect the Alan Bollard will stick to the March MPS script and signal little chance of reversing his insurance (cut) approach to monetary policy before the summer.

As it happens, this is also what the markets are expecting (following their recent up-and-down run in yield), with a 25bp hike not fully priced until January 2012, and a 3.00% cash rate not until around this time next year. We continue to think the pressure to hike, from the reinstituted low of 2.50%, will become too much for even the RBNZ to ignore by late this year, call it December, although our stronger conviction is that the cash rate will end up materially higher than the market reckons for end-2012.

Westpac is picking the RBNZ will be able to hold off until the first quarter of 2012:

We expect this week’s RBNZ statement to be firmly on hold, while acknowledging that the post-quake data has held up better than might have been feared. We think the key phrase from March will be retained: “We expect that the current monetary policy accommodation will need to be removed once the rebuilding phase materialises. This will take some time.”

The other key ‘bias’ statement – “Future monetary policy adjustments will be guided by emerging economic data” – is likely to be removed. At the time this was intended to leave the door open for further cuts if necessary; now, the emerging data is turning market opinion towards the possibility of early rate hikes, which is probably not the impression the RBNZ will want to leave.

Interest rate markets are currently pricing a 60% chance of an OCR hike by December – a figure that was pegged back a little after the softer-than-expected March quarter inflation figures. We expect those odds to be downgraded further after this week’s review.

ASB is also currently picking the first hike will be in March next year, although this will be dependant on the start of reconstruction activity in Christchurch:

We expect the RBNZ to leave the OCR at 2.50% at the April OCR Review, and to continue to highlight the uncertainty that remains over the outlook for the economy. At the March Monetary Policy Statement, the RBNZ had cut the OCR by 50 basis points as an insurance move to support the economy following the February earthquake. Over the past six weeks the RBNZ has had the opportunity to refine its forecasts. However, a large degree of uncertainty remains – particularly around the likely timing of reconstruction. Nonetheless, it remains clear that the NZ economy remains fragile and in need of continued monetary support.

Survey results since the March MPS have confirmed the effects of the earthquake on consumer and business confidence have been substantial. In addition, GDP and CPI data highlighted the weakness in underlying activity even prior to the earthquake. While agricultural export commodity prices remain high, cautiousness within the agricultural sector has muted the impact on the economy. All this suggests little urgency for the RBNZ to return monetary policy to normal settings. As such, we expect the RBNZ will leave the OCR at emergency low settings until March 2012, although the timing of eventual OCR increases is contingent on a recovery in the underlying economy and the start of reconstruction activity.

Finally, ANZ economists say early 2012 may be too late for the first OCR hike:

The New Zealand economy is not booming, and stimulatory monetary policy is appropriate for now. However, given that activity looks set to pick up steadily from the second half of 2011, maintaining the OCR at current levels is unsustainable.

The Bank indicated in March that they expect to start raising rates in early 2012. We suspect this may prove a bit too late, and that the Bank may be taking the foot off the accelerator by the end of the year. Given the stuttering nature of the recovery and significant downside risks – particularly around the global economic outlook – we are anticipating a fairly modest tightening cycle, despite the magnitude of the job at hand.