RBNZ lifts OCR by 25 bps to 3% as expected; repeats that high NZ$ not sustainable, but also says it is reducing inflationary pressures

By Bernard Hickey

The Reserve Bank has hiked the Official Cash Rate by a further 25 basis points to 3%, as widely expected, and has repeated its warning the high New Zealand dollar is not sustainable.

However, it also introduced a comment about the high New Zealand dollar leading to lower inflationary pressure in its outlook for interest rates, suggesting continued strength may take some of the pressure off interest rates in future. The New Zealand dollar rose 30-40 basis points to 86.2 US immediately after the statement, which could be read as giving a green light for more currency strength. ANZ lifted its floating mortgage rate and main deposit rate by 25 basis points within an hour of the announcement. See Gareth Vaughan's article here.

The bank virtually repeated its comments on the economy, inflation and interest rates word for word from its March 13 summary. The only minor change was the comment about the high exchange rate lowering inflationary pressure and how the bank was taking that into account in its interest rate outlook.

"Headline inflation is moderate, but inflationary pressures are increasing and are expected to continue doing so over the next two years," Governor Graeme Wheeler said in a statement.

This OCR decision is the 'in-between' six-paragraph statement released in between full quarterly Monetary Policy Statements that include fresh forecasts, extra commentary, a news conference and a Parliamentary Select Committee appearance by the bank's governors.

The March 13 Monetary Policy Statement included the bank's forecast that short term interest rates would rise by more than 2% to over 5% over the next two years, suggesting floating mortgage rates would rise to over 8%. The next full set of forecasts and commentary is due on June 12.

"In this environment it is important that inflation expectations remain contained," Wheeler said. "To achieve this it is necessary to raise interest rates towards a level at which they are no longer adding to demand," he said.

"The speed and extent to which the OCR will be raised will depend on economic data and our continuing assessment of emerging inflationary pressures, including the extent to which the high exchange rate leads to lower inflationary pressure," he said. "By increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point, the Bank is seeking to ensure that the economic expansion can be sustained."

Economist reaction:

ASB Chief Economist Nick Tuffley said he now expected the Reserve Bank to hike again in June, but then have an extended pause.

"The RBNZ noted downside risk factors such as weaker dairy prices and the high NZD but did not appear overly concerned about their impact at this stage. And the RBNZ remains very upbeat about the growth outlook," Tuffley said.

"A June OCR increase is, however, more event-dependent than the last 2 increases have been."

ANZ Chief Economist Cameron Bagrie said the bank's statement was consistent with its March forecast for 200 basis points of OCR rises in two years.

"We continue to expect another 50 basis points of OCR rises before the end of the year, with the next hike to come in June. July cannot be ruled out if pricing intentions and inflation expectations start to move," Bagrie said.

He also pointed to the Reserve Bank's comment on the high currency easing inflation pressure.

"So we have somewhat of a currency hook. But for the currency to stymie the outlook for OCR hikes it has to change the outlook for jobs, and we don’t think that’s around the corner," Bagrie said.

"The best we can say is that the currency will influence the speed of the withdrawal of policy stimulus, as opposed to halt it in its tracks," he said.

Westpac Chief Economist Dominick Stephens said he still expected another hike in June, followed by one each in July and December, although the high currency now meant the July hike would be a close call. He said the Reserve Bank was probably now only looking at increasing the OCR by 175 basis points over the next two years, rather than the 200 basis points forecast in March.

"Absent any major surprises, the RBNZ will use the June Monetary Policy Statement to signal this slight moderation to the outlook for the OCR," Stephens said.

"The RBNZ will no-doubt also use the June MPS to clarify whether or not it intends to hike in July. Which way it leans is a fifty-fifty call. We are plumping for a June MPS that does signal a July hike. But we admit there is a strong chance that instead, the RBNZ will use the June MPS to announce a pause in the tightening cycle. In the latter scenario the next OCR hike would be delayed until September or October (with the timing of the election playing no role in the decision)," he said.

BNZ's Head of Research Stephen Toplis said he still expected two more hike in June and July. He said the TWI is around 2.3% above where the bank had assumed it would be, which would reduce CPI inflation by around 0.5%.

"It’s really hard for the RBNZ to justify rate hikes if its forecast inflation falls well below the mid-point of its target band. Therefore, it is safe to say that the longer the currency stays higher, the greater the chance that there is a pause in the tightening process. The RBNZ can tell all in June," Toplis said.

"Be that as it may, the key message remains the same. Don’t overlook that the first half of the statement speaks of a booming economy. Accordingly, the cash rate needs to get back to neutral, in the first instance, which is around 4.25 – 4.50%. It then needs to head above this level to hold in check domestic demand.  Assuming that the NZD eventually falls, all that near term strength will do is effect the timing of rate increases and not the eventual extent," he said.

JP Morgan Economist Ben Jarman said a June 12 pause was now possible.

"We see the RBNZ as likely to pause at one of the next two meetings, with our preference being the next decision, in June. Inflation has been the missing link to the narrative throughout the growth upswing, and following last week’s downside surprise for 1Q, we view the RBNZ as needing to see evidence that it is playing to script and moving up in convincing fashion to deliver the next hike, and the next such reading is not delivered until July," Jarman said.

Political reaction:

Labour Finance spokesman David Parker said the rate hike would not have been necessary if the Government had properly targeted the sources of inflation.Today’s interest rate rise wouldn’t have been necessary if the Government had been doing its job properly and targeting the sources of inflation, Labour says.

“The Government has dropped the ball on this. It could have been doing so much more. We will, and will be releasing details of how we will go about that next Tuesday,” David Parker said, referring to a speech he will give in Auckland on Monetary Policy.

Parker said Labour’s Kiwibuild policy (where the Government would build 100,000 houses in 10 years), its capital gains tax, controls on foreign ownership, and providing the Reserve Bank with more tools would stabilise inflationary pressures and mean that today’s rate hike was not necessary.

Labour Housing spokesman Phil Twyford said rates could peak at a level which would see first-home buyers in Auckland spending two-thirds of household income paying the mortgage. The Roost home loan affordability reports for March showed the biggest worsening in 12 years as interest rates and house prices rose.

“We have had five years of out-of-control house price increases which have seen the average Auckland house rise over 40 per cent while National has been in government," Twyford said.

“National’s failure to get a grip on the housing crisis – its refusal to tax speculators or build large numbers of new homes – is one of the reasons the Reserve Bank wants to put interest rates up. Low interest rates caused by the Global Financial Crisis, and the lack of demand in the economy, were the only thing good thing National could point to," he said.

“NZ interest rates are already higher than the rest of the developed world. Despite dropping export prices our exchange rate is going up with continuing job losses in export industries like forestry. Something has to change,” he said.

Green Party Co-leader Metiria Turei said the rate hike was a result of the Government's failure to limit power price inflation and the Auckland property market.

"The Green Party has long suggested a more actively managed housing sector to reduce housing speculation. As well, the unfettered electricity market, where prices are spiralling upward despite demand going down, is clearly not working," Turei said.

'We will introduce a capital gains tax, place restrictions on the foreign buy-up of housing, initiate a government-led programme of affordable house building, and introduce Progressive Ownership for first home buyers to stabilise house prices," she said.

Parsing the statements:

It can be useful to compare the Reserve Bank's summary statements paragraph-by-paragraph to see how the bank's thinking has changed. Here's the comparison, with today's statement, followed by the March 13 statement, and an explanation of the difference.

April 24 - The Reserve Bank today increased the OCR by 25 basis points to 3 percent. New Zealand’s economic expansion has considerable momentum, with GDP estimated to have grown by 3.5 percent in the year to March. Growth is gradually increasing in New Zealand’s trading partners, but inflation in those economies remains low. Global financial conditions continue to be very accommodating.

March 13 - The Reserve Bank today increased the OCR by 25 basis points to 2.75 percent. New Zealand’s economic expansion has considerable momentum, and growth is becoming more broad-based. GDP is estimated to have grown by 3.3 percent in the year to March. Growth is gradually increasing in New Zealand’s trading partners. However, improvements in major economies have required exceptional support from monetary policy. Global financial conditions continue to be very accommodating, with bond yields in most advanced countries low and equity markets performing strongly.

The difference: The Reserve Bank has revised up its March quarter growth forecast slightly to 3.5% from 3.3%. The editing was also tighter, which is much appreciated.

April 24 - Prices for New Zealand’s export commodities remain very high, though auction prices for dairy products have fallen by 20 percent in recent months. Domestically, the extended period of low interest rates and strong growth in construction sector activity are supporting the recovery. Net immigration continues to increase, boosting housing and consumer demand. Confidence remains very high among households and businesses, and measures of investment and employment intentions are positive.

March 13 - Prices for New Zealand’s export commodities remain very high, and especially for dairy. Domestically, the extended period of low interest rates and continued strong growth in construction sector activity have supported recovery. A rapid increase in net immigration over the past 18 months has also boosted housing and consumer demand. Confidence is very high among consumers and businesses, and hiring and investment intentions continue to increase.

The difference: The Reserve Bank noted the 20% fall in dairy prices in recent months. It has also reiterated its comments about the effects of strong net migration on growth and the housing markets, which is topical given Wednesday's very strong migration figures for the year to March.

April 24 - Spare capacity is being absorbed, and inflationary pressures are becoming apparent, especially in construction and other non-tradable sectors. The high exchange rate remains a headwind to the tradables sector, and along with low import price inflation has been holding down tradables inflation. The Bank does not believe the current level of the exchange rate is sustainable.

March 13 - Growth in demand has been absorbing spare capacity, and inflationary pressures are becoming apparent, especially in the non-tradables sector. In the tradables sector, weak import price inflation and the high exchange rate have held down inflation. The high exchange rate remains a headwind to the tradables sector. The Bank does not believe the current level of the exchange rate is sustainable in the long run.

The difference: The Reserve Bank has specifically singled out the construction sector as a source of inflation. The only slight difference in the bank's warning about the high New Zealand dollar is that it has dropped the qualifier about it being not sustainable "in the long run", suggesting it sees it as immediately unsustainable.

April 24 - There has been some moderation in the housing market. Restrictions on high loan-to-value ratio mortgage lending are easing pressure, and rising interest rates will have a further moderating influence. However, the increase in net immigration is adding to housing demand.

March 13 - There has been some moderation in the housing market. Restrictions on high loan-to-value ratio mortgage lending are starting to ease pressure, and rising interest rates will have a further moderating influence. However, the increase in net immigration flows will remain an offsetting influence.

The difference: Virtually no change, except the qualifier about the high LVR speed limits 'starting' to ease pressure on the market has been dropped. It clearly is now easing pressure on the market.

April 24 - Headline inflation is moderate, but inflationary pressures are increasing and are expected to continue doing so over the next two years. In this environment it is important that inflation expectations remain contained. To achieve this it is necessary to raise interest rates towards a level at which they are no longer adding to demand. The speed and extent to which the OCR will be raised will depend on economic data and our continuing assessment of emerging inflationary pressures, including the extent to which the high exchange rate leads to lower inflationary pressure.

March 13 - While headline inflation has been moderate, inflationary pressures are increasing and are expected to continue doing so over the next two years. In this environment it is important that inflation expectations remain contained. To achieve this it is necessary to raise interest rates towards a level at which they are no longer adding to demand. The Bank is commencing this adjustment today. The speed and extent to which the OCR will be raised will depend on economic data and our continuing assessment of emerging inflationary pressures.

The difference: This section is where the Reserve Bank has made its most significant tweak to its statement. It has introduced the variable of the high exchange rate directly into its assessment of how quickly it will need to increase the OCR. This is the key phrase about how the OCR will be raised depending on the bank's assessment of inflationary pressures: "including the extent to which the high exchange rate leads to lower inflationary pressure."

This suggests that if the exchange stays higher for longer, then the Reserve Bank may not have to increase the OCR as much as it previously thought. It means the tradeables sector, which includes exporters and those who compete with imports, is doing a lot of the heavy lifting of fighting inflation. Some might see this as a green light for a higher currency, giving the Reserve Bank sees it as one way to fight inflation.

April 24 - By increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point, the Bank is seeking to ensure that the economic expansion can be sustained.

March 13 - By increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point, the Bank is seeking to ensure that the economic expansion can be sustained.

The difference: Not a sausage. Or even a comma.

(Updated with parsing of the statements, jump in NZ dollar, political reaction, economist reaction)