RBNZ holds OCR at 2.5% for now; relaxed on underlying inflation in middle of 1-3% target band; future OCR hikes needed, but only if global fallout mild

By Bernard Hickey

The Reserve Bank has held the Official Cash Rate at a record low 2.5% and has signalled the OCR is likely to rise if a global slowdown had only a mild impact on the New Zealand economy.

The decision to hold was widely expected by economists, who have shifted out their forecasts for the first hike in the OCR to mid 2012 from early 2012 in the last week. See Alex Tarrant’s article from Tuesday here.

Reserve Bank Governor Alan Bollard said underlying inflation was settling near the middle of the bank’s 1-3% target band.

“Given the ongoing global economic and financial risks, it remains prudent to continue to keep the OCR on hold at 2.5 percent for now,” Bollard said in a statement.

“However, if global developments have only a mild impact on the New Zealand economy, it is likely that gradually increasing pressure on domestic resources will require future OCR increases,” he said.

Domestic economic activity had continued to expand at only a modest pace despite relatively strong commodity prices, Bollard said.

“More recently, domestic business confidence has fallen back somewhat. Further ahead, earthquake repairs and reconstruction in Canterbury are still expected to provide significant impetus for demand,” he said.

“As foreshadowed at the time of the September Monetary Policy Statement, there is a real risk that the European sovereign debt crisis could cause a further slowing in global activity, putting downward pressure on New Zealand’s commodity export prices.”

Bollard said the difficult international market conditions could also result in increased New Zealand bank funding costs over the coming year.

“Annual headline CPI inflation continues to be above the Bank’s 1 to 3 percent target band. That largely reflects the one-off effect of last year’s increase in the rate of GST. September quarter inflation data suggest that, once GST and other one-off influences have passed, underlying inflation is settling near 2 percent.”

Economist reaction

ANZ Economist Cameron Bagrie said it was clear that a 2.5 percent OCR was now seen as an appropriate setting, rather than an “emergency” one."

The next move in the OCR is still up, but only “if global developments have only a mild impact on the New Zealand economy”. 

We maintain our view of a mid-2012 OCR increase but the risk profile is clearly towards later as opposed to sooner in our minds.  This is based on our view that:  (a) we are starting to see more than a “mild” impact on New Zealand from the global scene (based on anecdotes as opposed to hard data); and (b) the consensus is too upbeat on how quickly the European situation could settle despite the best efforts of policymakers. 

ASB Economist Christina Leung said the OCR statement was similar to the September Monetary Policy Statement with global developments dominating.

We continue to expect the RBNZ will remain on hold until March next year, given little in the way of concrete signs that the European leaders are making significant progress in coming up with a comprehensive resolution to the debt crisis. Beyond the 25 basis point OCR increase in March, we expect a steady series of 25 basis point OCR increases at the subsequent meetings until the OCR reaches a peak of 4%.

Recent developments skew the risk to a later start, and the potential for pauses at some point in the tightening cycle.

JP Morgan Economist Ben Jarman said he had shifted his expectation for the first rate hike out to the March quarter from December.

With Dr Bollard stating that the upside global scenario will produce only “gradually increasing pressure on domestic resources”, and with no mention of the prior 50bps of easing being a now-unnecessary insurance measure, we now are looking at a delayed, and more conventional hiking cycle.

In contrast to our previous call for a 50bp hike in December, followed by a slower pace of hikes through next year, we now expect the RBNZ to start the cycle with a 25bp hike in March, accompanying the MPS, and to continue in increments of 25bps, finishing 2012 with policy rate at 3.5%.

BNZ Economist Stephen Toplis said the Reserve Bank had played with a "straight bat" and he kept his view that the OCR was unlikely to be hiked until mid 2012.

We recently pushed back our expectation of when the Reserve Bank would swing in to action until June 2012 (from March). Today’s statement is not inconsistent with this view. Nonetheless, it is worth noting that the statement is very similar to that issued by the Bank at its September MPS and at that time the Bank was looking at a first hike by March.

Following the OCR release swap yields rose modestly and the NZD jumped around 60 basis points. At face value, at least, this would suggest the statement was more hawkish than anticipated though, in the case of interest rate markets, offshore drivers may in fact have been the dominant factor.

On balance, the Reserve Bank is very much on the same page as we are. We are very nervous about the plight of the world but cling to the hope that New Zealand can fumble its way through the mire. While we hold to the  view that growth will improve it is only consistent to also believe that interest rates will forge higher. Of course, if the growth pick up forecast does not eventuate then we, and the Reserve Bank, will, no doubt, change our interest rate stance as well.

HSBC Economist Paul Bloxham said he still expected the Reserve Bank to unwind the March 10 emergency rate cut soon.

The risk is that the RBNZ sits still for longer than we previously expected, as global financial issues remain unresolved. We still expect the RBNZ unwind the emergency setting for policy rates soon.

However, while our central view has been for a move by year-end, the risk is that they sit still for longer.

Westpac Economist Dominick Stephens said he still expected the first hike to be 25 bps in June next year.

The NZ dollar immediately jumped 60pts and swap rates rose four basis points across the curve, a reaction in line with our impression that the statement was on the hawkish side of the range of possibilities. Interest rate markets are not fully pricing in an OCR hike until September next year, compared to the RBNZ’s projections for around March. We expect these two views to eventually meet in the middle.

(Updated with interactive chart below of official cash rates and links, video, ANZ comment, ASB comment, JP Morgan, HSBC, Westpac and BNZ comment)