RBNZ holds OCR at 2.5% as expected; says will need to remove stimulus in future, but expects to hold OCR through the end of 2013

By Bernard Hickey

The Reserve Bank has held the Official Cash Rate (OCR) at 2.5%, as expected, and has kept its guidance of unchanged rates through the end of 2013.

But the New Zealand dollar and wholesale interest rates rose after the bank warned it will have to "remove monetary stimulus" in future and stopped describing the New Zealand dollar as overvalued. Economists described the statement as bringing in a 'tightening bias'.

The central bank has sharpened its warnings about rapid house price inflation in Auckland and Christchurch and has indicated it is watching closely how that inflation spreads into the wider economy.

“The extent of the monetary policy response will depend largely on the degree to which the growing momentum in the housing market and construction sector spills over into inflation pressures," Governor Graeme Wheeler said in an eight paragraph statement after the OCR decision, which is made once every six weeks or so.

“Although removal of monetary stimulus will likely be needed in the future, we expect to keep the OCR unchanged through the end of the year," Wheeler said.

The banks' view of the economic outlook was broadly unchanged from its June 13 policy assessment, but the comments about the "extent of the monetary policy response" depending on spill-over inflation was new.

The bank's comment that monetary stimulus would need to be removed was also new, although its June 13 Monetary Policy Statement included forecasts of the 90 day bill rate indicating the bank expected to raise the OCR from the June quarter of 2014 onwards.

Economists and financial markets broadly agree that the Reserve Bank will start increasing the OCR from record lows from March 2014 and lift it by around 2-3% over the following two years. The bank's own 90 day bill forecasts imply hikes of around 1.5% by early 2016.

The Reserve Bank did however drop its description of the New Zealand dollar as 'over-valued', instead describing it just as 'high', given its fall in the last two months.

The bank made no comment about its expected imposition of a 'speed limit' on growth of high loan to value ratio (LVR) mortgages, as expected. The bank has been at pains in the past to separate monetary policy, which is all about controlling inflation, from prudential policy, which is all about keeping the banking system stable. The Reserve Bank has previously included its 'speed limit' in the prudential policy side of the bank.

Economists said the statement signalled the Reserve Bank had shifted to a tightening bias.

"The RBNZ has shifted to an explicit hiking bias," Westpac Chief Economist Dominick Stephens.

"Westpac has long held the view that rising house prices and the construction boom will provoke inflationary pressures, requiring an OCR hiking cycle that is much larger than the RBNZ has been forecasting," Stephens said.

"The RBNZ now seems to be coming around to that way of thinking. All up, we maintain our long-held views on the OCR," he said.

"We anticipate that the first hike will come in March 2014, and that the OCR will reach 5.5% by the end of 2016."

Here is my paragraph-by-paragraph comparison of the Reserve Banks' full statement today with the June 13 assessment. I have bolded the key differences and explained them in brackets.

July 25 - The Reserve Bank today left the Official Cash Rate (OCR) unchanged at 2.5 percent. The global outlook remains mixed, with the euro area still in recession and signs of slower growth in China and Australia, but more positive recent indicators in the United States and Japan.  Global debt markets have become more cautious due to uncertainty around the Federal Reserve’s anticipated exit from quantitative easing. (The RBNZ is referring to the jump in long term interest rates on talk the Fed may 'taper' its purchases of bonds)

June 13 – The Reserve Bank today left the Official Cash Rate (OCR) unchanged at 2.5%. The global outlook remains mixed with disappointing data in Europe and some other countries, and more positive indicators in the United States and Japan. Global financial sentiment continues to be buoyant and the medium term outlook for New Zealand's main trading partners remains firm.

July 25 - Growth in the New Zealand economy is picking up and, although uneven, is becoming more widespread across sectors.  Consumption is increasing and reconstruction in Canterbury will be reinforced by a broader national recovery in construction activity, particularly in Auckland.  This will support aggregate activity and eventually help to ease the housing shortage. (Nearly identical, apart from the comment about growth becoming more widespread)

June 13 – Growth in the New Zealand economy is picking up, but remains uneven across sectors. Consumption is increasing and reconstruction in Canterbury continues to gather pace and will be reinforced by a broader national recovery in construction activity, particularly in Auckland. This will support aggregate activity and eventually help to erase the housing shortage.

July 25 - In the meantime rapid house price inflation persists in Auckland and Canterbury.  As previously noted, the Reserve Bank does not want to see financial or price stability compromised by housing demand getting too far ahead of the supply response. (Identical)

June 13 - In the meantime rapid house price inflation persists in Auckland and Canterbury.  As previously noted, the Reserve Bank does not want to see financial or price stability compromised by housing demand getting too far ahead of the supply response.

July 25 - Despite having fallen on a trade-weighted basis since May 2013, the New Zealand dollar remains high and continues to be a headwind for the tradables sector, restricting export earnings and encouraging demand for imports.  Fiscal consolidation will weigh on aggregate demand over the projection horizon. (The key difference here is removing the 'overvalued' adjective and replacing it with 'high)

June 13 - Despite having fallen over the past few weeks, the New Zealand dollar remains overvalued and continues to be a headwind for the tradables sector, restricting export earnings and encouraging demand for imports.  Fiscal consolidation will weigh on aggregate demand over the projection horizon.

July 25 - CPI inflation has been very low over the past year, reflecting the high New Zealand dollar and strong international and domestic competition.  However, inflation is expected to trend upwards towards the mid-point of the 1-3 percent target band as growth accelerates over the coming year. (No change of view on inflation, although there is no mention of GDP growth accelerating to 3.5%.)

June 13 – Annual CPI inflation has been just below 1% since the September quarter of 2012, largely reflecting falling prices for tradable goods and services. While tradables inflation is likely to remain low, annual CPI inflation is expected to trend upwards through the forecast period. Reflecting the balance of several forces, we expect annual GDP growth to accelerate to about 3.5% by the second half of 2014, and inflation to rise towards the midpoint of the 1-3% target band.

July 25 - The extent of the monetary policy response will depend largely on the degree to which the growing momentum in the housing market and construction sector spills over into inflation pressures. (Brand new paragraph)

July 25 - Although removal of monetary stimulus will likely be needed in the future, we expect to keep the OCR unchanged through the end of the year. (The comment about removing stimulus is new in the policy assessment, although the bank's June 13 forecasts implied removal of stimulus from mid 2014).

June 13 – Given this outlook, we expect to keep the OCR unchanged through the end of the year.

Here's some economist reaction. The bolding is mine.

ASB's Nick Tuffley:

The statement does indicate that the RBNZ’s concerns over house prices and housing-related inflation are continuing to escalate, the theme of RBNZ statements since the start of the year. That has brought a slightly firmer tone to the policy conclusion. The influence of the housing market on inflation is becoming more apparent: the underlying pick-up in retail spending and one quarter of sharp construction cost inflation in Auckland (one quarter does not make a trend, but does give a warning of the risks).

We continue to expect the RBNZ to keep the OCR on hold until March 2014, with the OCR gradually rising to 4% in late 2015. That start is earlier than the June start implied in the June MPS forecasts: we continue to anticipate the RBNZ’s concerns over housing and more general inflation will prompt earlier action than the RBNZ has envisaged. We judge the risks around our March view as broadly balanced, and today’s statement reinforces that an earlier start is a realistic possibility if housing/construction flow-through to inflation is swift. We also see a strong likelihood of the RBNZ implementing LVR restrictions later this year, assuming any implementation issues are resolved.

Westpac's Dominick Stephens:

The RBNZ has shifted to an explicit hiking bias. This is the first material change in the stance of monetary policy since December 2011, when the RBNZ adopted and maintained its "firmly on hold" bias. We see this as a signal that the RBNZ now expects to hike the OCR in early, rather than late, 2014.

The real motivation for the RBNZ's change in stance came in the paragraphs concerning inflation. For the first time, the expected rise in inflation was explicitly linked to accelerating growth. This is very significant. For a long while the RBNZ had maintained the assumption that rising house prices and the construction boom would not prove inflationary. It seems that the RBNZ is beginning to abandon that view, and is taking more seriously the potential inflationary consequences of the buoyant economy. 

Westpac has long held the view that rising house prices and the construction boom will provoke inflationary pressures, requiring an OCR hiking cycle that is much larger than the RBNZ has been forecasting. The RBNZ now seems to be coming around to that way of thinking. All up, we maintain our long-held views on the OCR. We anticipate that the first hike will come in March 2014, and that the OCR will reach 5.5% by the end of 2016.

ANZ's economists said the statement was "business as usual":

That said, more confidence was evident on the domestic pick-up, and there was a clear tightening bias with acknowledgement that the removal of monetary policy stimulus will “likely” be needed in the future.

We’re still picking early 2014. The precise date is somewhat secondary with the real issue being at what pace and regularity the OCR ends up being lifted. We’re in the gradual camp. The RBNZ now views the extent of stimulus withdrawal as being more closely tied to the spill-over of construction sector inflation into the broader economy.

For such inflation to prove to be contained, we need to see more evidence that households have made a structural change in spending behaviour (and a policy platform to encourage it). A housing boom will sorely test that hypothesis. But the fact is, NZ can ill afford a construction and consumption boom at the same time. The latter needs to be the sacrificial pawn for the former.

The microeconomic arena in regard to housing (and savings) will take on heightened importance and needs to be closely watched. We’re picking a continuation of “supportive” policies aimed at mitigating housing’s supply-demand extremes but none to be a silver bullet.

BNZ's Stephen Toplis was less sure about a new 'tightening bias':

By and large, today’s OCR review was simply a restatement of the June MPS. Indeed, much of the text was identical. The only slight change was the stated admission that the “removal of monetary stimulus will likely be needed in the future”. But while a few folk got excited by this, it was hardly ground-breaking news given that the RBNZ’s previously published interest rate track clearly expresses a tightening trend.

The Reserve Bank has stuck to its mantra that it expects “to keep the OCR unchanged through the end of the year”. We maintain that these are weasel words that are not entirely consistent with the Bank’s rate track, which shows a first rate increase in Q3 2014. We will stick with our view that the first hike in rates will be Q1, 2014 and most likely in March.

TD Securities' Annette Beacher:

All eyes were on the Governor’s take on the NZD, but the stock phrase of “the NZD remains high” was swiftly ignored, and instead all eyes focused on the introduction of “removal of monetary stimulus will likely be needed in the future” i.e. a clear tightening bias. The NZD wobbled then jumped 40pips to $US0.7980 and 2yr IRS up +4bp on digesting the unexpected hawkish tone. 

HSBC's Paul Bloxham sees a rate hike by the end of the year:

In our view, inflation pressures are likely to rise from here. Developments in the housing sector are already beginning to concern the RBNZ on the inflation front and the economy is already operating at close to full capacity. We see upside inflation risks stemming from the rebuild and the New Zealand housing market. As such, the RBNZ may need to consider rate hikes as early as the end of this year. 

(Updated with charts, detail on no comment about high LVRs speed limit, economists' reaction)