Economists expect OCR to stay on hold on Thursday, start to get excited about RBNZ views on new govt policy and implications for growth and inflation ahead of new employment target and new Governor

By Alex Tarrant

To quote ANZ economists, “the picture is hardly clear cut.”

While the Official Cash Rate (OCR) is expected to remain once again at 1.75%, there is increased excitement around the Reserve Bank’s Thursday Monetary Policy Statement (MPS) than previous no-change occasions.

Economists say they’ll be searching for clues on how the new government’s policies will be interpreted by the central bank, particularly how promises for higher government spending, wage and transfer boosts could feed through to inflationary pressure.

Add in a lower currency – meaning upward pressure on tradable inflation – and some are suggesting the Reserve Bank could become more hawkish on Thursday than it was in August on a number of key metrics.

But slightly lower growth forecasts – hinted at by the Bank in September – could mitigate that pressure. Uncertainty around the housing market and migration settings, with core CPI inflation also stable at 1.4% (below the 2% target band mid-point), could keep the Bank from shifting too much on its overall stance.

The “messy outlook” described by ASB’s economists should become clearer sometime in December, with Treasury set to release its Half-Year Economic and Fiscal Update, with suggestions that it could be accompanied by a mini-Budget from Finance Minister Grant Robertson detailing spending commitments which emerged during coalition negotiations. 

This means the Bank’s army of economists and analysts will have a solid three months to analyse new spending, inflation and growth tracks by the time of the next quarterly MPS rolls around, on 8 February 2018.

This is due a month-and-a-half before interim Bank Governor Grant Spencer stands aside – we might even know who’s going to replace him by then, and have a sense of how the new government will articulate its desire to add full employment alongside price stability to the Reserve Bank’s legislation.

So, if you think Thursday’s MPS will be an exciting occasion, Reserve Bank watchers should be over the moon in February, then again in May at the new Governor’s first MPS. It certainly shouldn’t be a boring 2018.

Below are several economists’ previews on Thursday’s OCR announcement and MPS:

ANZ:

• The RBNZ will again leave the OCR at 1.75% and maintain a cautious and watchful stance.
• Some changes to the Bank’s economic forecasts are likely (growth downgraded, but inflation upgraded). However, we suspect the interest rate projections will remain broadly unchanged.
• We remain biased to OCR hikes in time but questions surround the timing. Shifts in policy direction (more fiscal impulse and Government intervention) likely mean a lower currency / higher rates mix of monetary conditions.

KEY POINTS
·         We expect the RBNZ to again leave the OCR at 1.75% at its Monetary Policy Statement next Thursday (9am). The Bank has maintained a cautious and watchful stance for a number of months now and we don’t see that changing. The Bank will still judge that “Monetary policy will remain accommodative for a considerable period.”

·         Since the September OCR Review we note:

−     There is more political clarity in many respects, but still plenty of uncertainty. Fiscal policy will become far more expansionary, but to what extent is unclear, particularly when it needs to be weighed up against possible housing and migration restrictions.

−     Housing market activity has remained soft. Turnover is the lowest since 2011 and annual house price growth is broadly flat. Post-election anecdotes have remained weak.

−     Forward growth indictors are more mixed. Consumer confidence is still decent, but business sentiment has waned. Job ads growth has cooled and our Truckometer is providing a soft signal for Q3. Weaker housing market activity portends potential negative spill-overs. 

−     The NZD is meaningfully lower. It is ~4% lower than at the time of the OCR Review and ~6% lower than where the RBNZ assumed it would be in its August MPS projections. At the same time, export commodity prices have held up; that is growth positive.

−     Headline inflation surprised on the upside. Headline CPI rose 0.5% q/q in Q3, well above the RBNZ’s 0.2% q/q pick. While the majority of this surprise will have reflected food and petrol price moves, it does mean the RBNZ’s forecast of just 0.7% y/y inflation by Q1 2018 is looking far less likely.

−     But core inflation was broadly stable. Non-tradable inflation did record its biggest seasonally adjusted quarterly increase in close to four years and the weighted median and trimmed mean both sat at 2%. However, the Sectoral Factor Model – the RBNZ’s preferred measure – was stable at 1.4%.

−     The labour market is tight. We suspect the RBNZ will discount the outsized Q3 moves in employment and participation, but the unemployment rate at 4.6% is a solid signal. Plenty of questions remain over wages though, with private sector wage inflation steady outside of the impact of the care and support workers settlement.

−     The global growth backdrop remains positive. The global economy is experiencing its strongest and most broad-based period of growth since the financial crisis. Confidence measures are elevated and financial market volatility is low. More global central banks are slowly climbing onto the tightening bandwagon.

·         So the picture is hardly clear cut. Developments have been mixed to say the least, no doubt leaving the RBNZ with the view that “numerous uncertainties remain”. What has struck us since the RBNZ shifted to a ‘dovishly neutral’ stance earlier this year is that even though there have been data surprises along the way, its stance and view on the outlook have barely shifted. It is looking through the noise and focusing on the overall trend. So to us, while the noise level may have increased over the past couple of weeks, the trend is still not clear enough to warrant a shift in the RBNZ’s message. We suspect it will remain happy to sit on the side-lines from a policy perspective.

·         With regards to the RBNZ’s forecasts, there will be some movement. The RBNZ already hinted in September that it would tweak its growth forecasts lower, and we expect the sequential pace to be lowered from 0.9-1.0% q/q towards perhaps 0.8% q/q – at least in the near term. And as mentioned above, in August the RBNZ projected inflation to drop to 0.7% y/y in Q1 2018. That now looks unrealistic given the higher starting point, lower NZD and perhaps even what we have learned on the government policy front. A trough slightly above 1% is now more likely.

·         But we expect changes to the interest rate projection to be small, if any. In both the May and August Statements, the RBNZ implied OCR hikes from late 2019. While the lower NZD since then is particularly relevant, we are of the view that the RBNZ will be reluctant to shift this hike timing, given the risk it might be perceived as providing clarity over the estimated impact of the broader Government policy direction. That clarity is not there yet (at least not to such a degree that a central bank can respond to it), so the RBNZ will be inclined to hold steady.

·         Looking forward, we are still biased to OCR hikes in time. The policy mix under the new Government appears likely to mean a lower NZD / higher interest rate combination for monetary conditions. The timing of the first hike is still unclear, but we continue to lean towards late 2018.

ASB:

• The RBNZ is widely expected to leave the OCR on hold at 1.75% and continue to emphasise that interest rates are likely to remain low for a prolonged period.
• Economic developments suggest little change in the policy outlook is required.
• It is too soon, and details too light, to incorporate policy changes from the incoming Government.

The Reserve Bank of New Zealand (RBNZ) is facing an outlook of many moving parts, with uncertainties remaining over the policy outlook which makes November an awkward time to deliver a set of forecasts.  The change in Government will bring a range of new policies that will likely tweak the economic outlook.  But it is too soon for the RBNZ to properly assess the economic and inflation impacts.  Furthermore, the incoming Government also has announced a review of the RBNZ Act and Policy Targets Agreement.   The RBNZ is about to present a set of forecasts fully aware that the economic forecasts will change and that the RBNZ’s own objectives and ways its sets monetary policy could also change.

Meanwhile, economic developments have continued in a similar vein this year, with near-term inflation lifting but growth proving a bit softer than expected.  Given the messy outlook, the RBNZ is best to keep the policy assessment similar to previous statements; emphasise that interest rates will remain low for a prolonged period and highlight the many uncertainties on the outlook.

BNZ:

Economic Outlook 
We have had a go at recasting our forecasts based on current information on likely government policies. This should be thought of as work in progress and will evolve as we get more detail. As they stand, our new forecasts will likely grate with those in the market forming a softer view on NZ (and the RBNZ). Big-picture, our GDP growth expectations are largely unchanged though different in composition; inflation more surely gets up around 2%; government debt threatens to track much higher than the Labour party has signalled and; corporate margins are crimped as input costs rise. For the record, the RBNZ’s August MPS published GDP growth track was 3.1% for the year ended March 2018; followed by 3.6% in 2019 and 2.9% in 2020. Our equivalents are 2.5%, 3.0% and 2.5%. Treasury’s Budget had 3.4%, 3.8% and 3.1% over the same period. If we are correct then there is clearly downside risk to government revenues which will be problematic for the government’s expenditure plans. There are no data of great significance over the coming fortnight. 

Interest Rate Outlook and Strategy 
The OIS market has pushed the timing of the first full 25bp rate hike to February 2019 from November 2018 and NZ 2 year swap has fallen 4bps to 2.16% largely on political headlines. We think that the NZ front end rally has been excessive. We suspect the politics-related receiving theme will run out of legs. We expect the RBNZ to hold the OCR at 1.75% next Thursday, but we believe the balance of recent economic developments will almost certainly see the Bank revise up its inflation forecasts. It is less certain what the bank will choose to do with its interest rate track. In any case, there seems very little chance that the RBNZ’s tone will be more dovish that it was in August and it may well be noticeably more hawkish. Our bias is for a constrained sell-off in the front end, seeing 2 year swap in a 2.10-2.30% range. 5s look too rich on swap curve against 2s and 10s. 

Currency Outlook 
Domestic political forces have seen the NZD underperform since the election, across a broad range of currencies. We see the NZD as oversold on this basis, given our view that the market need not fear a (small) change in government policy direction. Our short-term fair value model estimate has broadly tracked around USD0.72-0.73 since the election, supported by high risk appetite. This compares to current spot levels at sub USD0.70. A fading of the NZ political risk premium supports a closing of the valuation gap over the near-term and a broadly based recovery on most crosses. Next week’s RBNZ MPS should be NZD-supportive as the Bank lifts its inflation forecasts. We see no need to change our NZD projections, which have the currency anchored around USD0.69-0.70 through the next 12 months. 

Westpac:

• We expect the RBNZ to keep the OCR on hold and give the same neutral policy guidance that it has given all year.
• We expect the OCR forecast to be the same as the August MPS – flat until 2019 and slowly rising beyond that.
• The economic outlook has deteriorated, and the housing market is weaker than the RBNZ anticipated.
• But the exchange rate has fallen sharply, meaning the overall outlook for medium term inflation is broadly unchanged. 

The change of Government makes the economic outlook more uncertain. The RBNZ is better off waiting and seeing how Government policy evolves, rather than making bold changes at this point.
There would be very little financial market reaction to a neutral MPS along these lines.

Since early this year the RBNZ has been the Switzerland of central banks, remaining strictly and consistently neutral. The RBNZ has repeated the same bottom-line guidance paragraph, more or less unchanged, since February this year:

“Monetary policy will remain accommodative for a considerable period. Numerous uncertainties remain and policy may need to adjust accordingly.”

Correspondingly, the RBNZ has repeatedly published a flat forecast for the OCR, with OCR hikes in the picture only from 2019.

However, in recent times New Zealand’s economic landscape has been changing. The construction sector seemed to stall for much of this year; GDP growth has been below expectations; businesses’ confidence in their trading outlook has fallen; the house price boom came to a halt; and consumer spending has flat lined since April. To date the RBNZ has been running with very upbeat forecasts for economic growth and house prices into 2018, but this needs to change. The RBNZ will run with lower near-term GDP and house price forecasts in next week’s Monetary Policy Statement. 

On the other side of the ledger, inflation was higher than expected in the September quarter, and December is also shaping up as a high inflation quarter. But this has been almost entirely due to transitory factors such as petrol prices. It does not affect the deeper fact that underlying inflation is below the RBNZ’s 2% forecast. Similarly, unemployment has been falling, but that is a lagging indicator. The outlook for the coming year still suggests that the RBNZ must keep interest rates low if it wants inflation to reach 2% on a sustained basis.

At the time of the September OCR Review, the RBNZ hinted that it was going to lower its GDP forecast. It said GDP growth was going to “maintain its current pace” rather than the previous phrase that growth would “improve”. At the time, we argued that this could be a prelude to a more dovish tone in the November MPS. However, there was always an important caveat to that – we said “The remaining determinant of the overall tone in November will be the exchange rate. If it falls by enough to provide some prospective stimulus to inflation, the RBNZ would be able to leave its OCR guidance unchanged.”

That is exactly what has happened. The exchange rate has fallen sharply and unexpectedly in recent weeks, mainly due to the election outcome. The Trade Weighted Index is now 6% lower than the RBNZ forecast in the August MPS. This will provide some much-needed stimulus to the RBNZ’s inflation forecast, and will allow the RBNZ to run with the same OCR forecast as previously.

We now expect that the RBNZ will repeat the same guidance paragraph and issue the same flat OCR forecast as in recent Monetary Policy Statements.

The other reason to expect a “straight bat” from the RBNZ at next week’s Monetary Policy Statement is that the election result has made the economic outlook so much more uncertain. The new Government is intent on change, and is prioritising its housing policies. This will have a difficult-to-determine negative impact on house prices over 2018. The Reserve Bank needs to reduce its house price forecast, which in turn will affect its consumer spending forecast. But it won’t know where to pitch these forecasts until it hears more policy specifics. The Government plans to cancel next year’s tax cuts, but to spend more over time – it won’t be easy to anticipate the net impact on inflation until the exact policies are published. And so on and so forth. At this stage, the Reserve Bank is better off waiting and seeing what happens with Government policy, rather than reacting prematurely to policy changes that may or may not eventuate. 

We do not expect the mooted changes to the Reserve Bank Act to make much difference to next week’s OCR decision – the Acting Governor will be operating under current law for his entire six-month term, and is legally obliged to heed the current Policy Targets Agreement. 

Apart from the unchanged OCR forecast and policy guidance paragraph, the key features of the MPS that we expect are:

• Reference to the improving world economy and rising global equity prices.
• Acknowledgement that the lower exchange rate, if sustained, will help to increase tradables inflation and deliver more balanced growth (previously, “A lower NZD would help…”).
• Acknowledgement that the GDP outlook is weaker than in previous forecasts, partly due to less growth in construction than anticipated.
• Acknowledgement that house prices are lower than previously anticipated, although the outlook remains uncertain.
• The RBNZ may water down or remove its warning that headline in inflation will fall next year, since the lower exchange rate makes that less certain. However, we expect a repeat of the key sentence that “Non tradables inflation remains moderate but is expected to increase gradually … ,bringing headline inflation to the midpoint of the target range over the medium term.”
• There would be very little financial market reaction to an MPS along the lines we propose.