RBNZ holds at 3.5%; reduces forecast interest rate peak by 50 bps to 4.7% by 2017; warns NZ$ "unjustified, unsustainable."

By Bernard Hickey

The Reserve Bank of New Zealand has held the Official Cash Rate at 3.5%, as expected, and reduced its forecast peak for interest rates by around 0.5% to around 4.8% by 2017.

Economists saw the statement and the Reserve Bank's forecasts as dovish and some delayed their forecasts for the next rate hike until mid 2015 from early 2015 or December this year.

Westpac Chief Economist Dominick Stephens changed his forecast for the next OCR hike to June 2015 from January 2015 and lowered his expectations for OCR hikes in 2015 to 75 basis points from 100 basis points. JP Morgan and TD Securities changed their OCR hike views to March 2015 from December 2014. ANZ said it may change its rate hike view from March to June if the New Zealand dollar doesn't fall as expected.

"The Reserve Bank has made it obvious that it is now in a different mood. Although the RBNZ's GDP forecast has changed little from previous statements, the RBNZ has changed its judgements around how economic growth will affect inflation," Stephens said.

Citing a slowing housing market and a lower than expected boost to housing and demand from migration, the Reserve Bank said it wanted to take some time to see how its four rate hikes since March, its high LVR speed limit and lower commodity prices would affect inflation.

Governor Graeme Wheeler said CPI inflation remained moderate, reflecting subdued wage increases, well-anchored inflation expectations, weak global inflation, and the high New Zealand dollar.

However, he warned spare capacity is being absorbed, and annual non-tradables inflation was expected to increase. He said risks remained around how strongly net immigration would affect housing demand, and how inflation would be generated by the construction sector.

"In light of these uncertainties, and in order to better assess the moderating effects of the recent policy tightening and export price reductions, it is prudent to undertake a period of monitoring and assessment before considering further policy adjustment," Wheeler said.

"Nevertheless, we expect some further policy tightening will be necessary to keep future average inflation near the 2 percent target mid-point and ensure that the economic expansion can be sustained," he said.

Currency warning

Wheeler repeated his warning about the high New Zealand dollar, saying it was restraining growth in the traded sector.

"The exchange rate has yet to adjust materially to the lower commodity prices. Its current level remains unjustified and unsustainable," he said.

"We expect a further significant depreciation, which should be reinforced as monetary policy in the US begins to normalise."

The New Zealand dollar dropped under 82 USc after the statement and the repeated warning about the currency being unsustainable.

Wheeler declined comment on whether the Reserve Bank had intervened in currency markets, or whether it would.

He also declined comment on the Government's plan to double first home buyer subsidies.

Reaction

BNZ Head of Research Stephen Toplis said the Reserve Bank appeared a "bit bamboozled" as to why inflation was as low as it was.

"Accordingly, not only has the Bank today offered a less aggressive interest rate track than it has done previously but it has also intimated that the risks to that track are biased to the downside," Toplis said.

Toplis said the bank had been deliberately vague about when the next rate hike might be.

"RBNZ staff members have been quick to point out that the actual view of the Bank is that the cash rate will probably next be raised sometime between December 2014 and September 2015. This is a distinct softening from the June MPS when December was clearly signaled," he said, adding however he was sticking to his view that the next rate hike would be in March.

ANZ Chief Economist Cameron Bagrie said rate hikes would resume next March at the earliest. "Indeed, if the NZD doesn’t continue to move lower, we’ll push it out to June," Bagrie said.

"We’re not believers in a new paradigm for inflation, but we certainly believe some inflation suppressants deserve more attention; productivity growth looks strong and credit growth is below nominal GDP," he said.

ASB Senior Economist Chris Tennent Brown said ASB still expected a March hike, "but the remainder of the tightening cycle could be slightly more elongated than previously forecast."

"The RBNZ is firmly on hold.  There is a lot of thinking going on inside the RBNZ about the relatively mild impacts (compared to the past) of migration and general capacity pressures on inflation," Tennent Brown said.

ASB sees three OCR hikes in 2015, before one more in March 2016 to reach a peak of 4.5% three months later than previously assumed.

JP Morgan's Ben Jarman shifted his expectation of the next rate hike out to March 2015 from December this year and highlighted the Reserve Bank's more relaxed view about migration.

"For a small open economy like New Zealand, this change in view on migration is a big deal," Jarman said.

"First, it allows more of the recent growth upswing to be characterized as a positive potential growth shock. That allows policy some near-term flexibility. Second, and as important, the more front-loaded impulse to the supply side from immigration keeps inflation benign for another year, and bridges the crucial gap between the RBNZ’s rate normalization, and that in the developed markets," he said.

(Updated with currency moves, Westpac change of OCR hike view, BNZ comments, ASB comments, JP Morgan comments)