No changes to the country's monetary policy settings are expected when the Reserve Bank has its first review of the year next week - but everybody will be looking for clues as to what comes next

Nothing will happen when the Reserve Bank has its first review of monetary policy for the year on Wednesday, February 24. But that doesn't mean it will be dull. Oh, no. Not at all.

What the RBNZ says in its first major communication with the marketplace for 2021 will give us a vital insight into how it sees the immediate future.

You can regard it as a slam-dunk certainty that the Official Cash Rate (which as has now been at 0.25% since March last year) won't change. So 'nothing' will happen in the physical sense.

But economists will be watching with great interest what signals of things ahead the RBNZ may give, as it grapples with a fast-evolving economic situation. 

The backdrop to the latest RBNZ Monetary Policy Statement (and first since November 2020) is that the economy has performed to date so much better than when the central bank went into Covid crisis mode last March and began throwing the kitchen sink at the economy.

Such has been the recovery in New Zealand's economy in recent months that the talk has switched. Even quite late last year we were thinking interest rates may be forced below zero - negative interest rates. Instead, now economists are even talking about when the RBNZ may actually start increasing interest rates again - with some even suggesting as early next year. Wholesale interest rates have been rising in line with such expectations.

And then there's the not-small matter of the QE, or to give it its official name - Large Scale Asset Purchase programme. This currently has the RBNZ committed to buy up to $100 billion of bonds by June 2022. 

Key points of focus

A key point of focus for economists in the latest MPS will be whether any change is signalled to this programme. Some economists are even suggesting the RBNZ may soon wind down or even end this programme, possibly with less than $100 billion worth purchased.

And then there's the 'Flip', AKA the Funding for Lending Programme, launched just before the end of 2020, in which the RBNZ may lend up to $28 billion at the OCR rate (so, currently just 0.25%)  to banks over the next two years. Might some changes be made to this?

In terms of what the RBNZ may say and do, there's probably more divergence among economists views than you might normally see at the moment. And that's probably understandable. Some kind of economic Armageddon looked possible last March - and yet the reaction of our economy has been so much better than that. 

How the RBNZ will react on an ongoing basis is not so easy to read.

The RBNZ has to date remained very cautious and has continued to maintain fairly downbeat assessments of where Covid may take the economy. But the economy has continued to perform better to this point than the RBNZ has expected, but in fairness, that might not continue to be the case. What if we do have a really bad re-emergence of Covid in NZ?

It is little wonder therefore there's something of a divergence of opinion between economists and other market watchers who expect the central bank keeping things very much on the same track for the foreseeable future - versus those perhaps seeing a need to change policy settings, with a view towards having to raise interest rates sooner than might have been thought.

At the nub of much of the divergence is the extent to which one believes that the resilience the New Zealand economy has shown in the face of Covid will continue, or whether such things as the spending by Kiwis locally that would have been used for overseas holidays starts to fizzle out. And then there's the extent to which a summer bereft of overseas tourists may gradually become more and more of a drag on the economy.

All of which means that whatever the RBNZ says in its decision next week is going to be pretty vital stuff that will set the expectations and the tone in the marketplace this year. 

I've had a read of what some of the top New Zealand economists are saying ahead of the Wednesday MPS and a summary of some of the choice comments follows:

ASB sees OCR move next year

ASB chief economist Nick Tuffley notes that the starting point for the RBNZ’s economic outlook "is much better than was assumed late last year".

"The RBNZ’s medium-term economic objectives look to be much closer to being met and we expect the OCR to move up from the second half of 2022.

"Nevertheless, we expect the RBNZ will keep the emphasis on the continued risks, challenges and uncertainties."

He says the NZ economy is currently in a much better position than many had earlier envisaged, including the RBNZ. 

"Its dual inflation and maximum sustainable employment targets are that much closer to being reached again on a sustained basis.  In our view, the huge monetary policy stimulus in place at present is likely to start getting unwound a little sooner than anyone would have contemplated even late last year.

"Consequently, we now expect the RBNZ to start lifting the OCR gradually from the second half of next year (we have pencilled in August 2022).  At that point drawdowns for the first tranche of the Funding for Lending Programme will have closed, leaving only the ‘bonus’ portion based off banks’ new lending growth to be drawn down before year-end.  We also see no need for the Large Scale Asset Purchase programme (i.e. quantitative easing or QE) to have its limit increased from the current $100 billion cap, though expect that at some point the RBNZ will extend the end date of asset purchases from mid-2022."

ANZ sees RBNZ tempering the better economic outlook with caution

ANZ chief economist Sharon Zollner, senior economist Liz Kendall and senior strategist David Croy see a much more cautious line:

"Overall, the RBNZ will acknowledge –and be encouraged by – the better [economic] outlook,but will temper that with some caution," they say.

"Striking the right balance will be a communication challenge. Stoking expectations of policy normalisation could cause an unwelcome further tightening in financial conditions, with global markets in steepening mode and long-end yields under upward pressure. But equally, erring too much on the dovish side may not be seen as credible."

They believe that with the economic picture considerably brighter than at the time of the release of the November MPS, the RBNZ will revise up its forecasts for GDP, employment and inflation. "The medium-term outlook is now more assured and this will be clearly acknowledged," they say.

"That said, we expect the RBNZ will signal that removal of policy stimulus remains a long way off.

"We may see the addition of further forward guidance, stressing that the policy outlook is highly conditional on developments and that OCR hikes remain a long way off, potentially even putting a (highly conditional) date on it (2023 at the earliest)."

They expect the time-frame of the LSAP programme to be extended to the end of 2022, in line with lower bond issuance and policy remaining stimulatory for some time yet. Formalised RBNZ Monetary Policy Committee-directed tapering of bond purchases "is expected to be the first step on the path to policy normalisation and may occur late next year".

"Expressing the LSAP programme in terms of the pace of purchases (rather than its $100 billion limit) would provide needed clarity to markets, and would assist in communicating eventual tapering. A change in communication could occur as early as next week.

"Markets have moved a long way since November, with a small chance of OCR hikes priced in over the next two years. We could see pricing for future OCR hikes pushed out if the RBNZ chooses to provide more explicit guidance that policy will remain easy for quite some time yet."

Westpac sees stimulatory monetary policy for 'an extended period'

Westpac chief economist Dominick Stephens expects the RBNZ’s key message will be that it intends to keep monetary policy very stimulatory for an extended period, even if inflation pops higher in the near term.

"However, the RBNZ might talk less about looming downside risks, and will probably not actively promote the possibility of further OCR cuts, as it did over most of last year."

While markets are "flirting with the idea" of the RBNZ lifting the OCR, Stephens we expects no hike until early-2024.

"The nub of the matter is inflation. We expect inflation will spike to 2.5% by June this year, mainly due to supply-side constraints, shipping delays, and rising commodity prices. However, such disruptions to supply will be temporary. We expect inflation will fall to 0.8% by June 2022 as disruptions to global supply chains ease and commodity prices stabilise or fall. We also expect a big lift in the exchange rate, to 78 cents against the USD, which will further constrain inflation.

"Finally, the economy is still grappling with the large hole in demand resulting from the lack of international tourism. Consequently, while we are seeing a pick-up in sectors like housing and construction, the economy as a whole is still operating with significant spare capacity. The resulting hole in demand will constrain domestically-generated inflation and keep employment below the maximum sustainable level. We don’t expect that the economy will be operating at full capacity until early-2022. If we are right, and inflation does drop below 1%, the RBNZ will have little cause to lift the OCR."

On the LSAP programme, Stephens notes that previously, the Monetary Policy Committee instructed staff to purchase “up to $100 billion” of bonds by June 2022, with the aim of keeping interest rates low across the curve.

"But in early 2021 the RBNZ sharply reduced the rate at which it purchases bonds, such that it is now on track to purchase a total of only $85 billion by June 2022. Interest rates on long-term Government bond rates rose sharply, but there was no adjustment to the pace of bond buying to correct this.

"Maybe we are barking up the wrong tree, but it seems a lot like the RBNZ has decided to slow the pace of bond purchases and allow long-term interest rates to rise, even though no such policy decision has been announced.

"Our central scenario is that next week the RBNZ will maintain the status quo on the LSAP. But there is a possibility that it will provide some clarity on why it has slowed the bond purchases, along with some guidance on the pace of LSAP purchases going forward. This could take the form of a change in the LSAP cap or some other acknowledgement that the LSAP is already proceeding more slowly than previously planned. We certainly think something along these lines would be an improvement in the transparency of the LSAP."

BNZ says the RBNZ 'must be less dovish'

BNZ head of research Stephen Toplis, believes the RBNZ will raise interest rates next year and "must be" less 'dovish' than it was in November.

"Nearly every economic development since that November missive has portrayed a stronger, and more inflationary, economy than was expected. This is not a criticism of the RBNZ, as the data flow has bamboozled everyone. But the world is unequivocally different to what we had all expected, and the Reserve Bank will have to recognise this.

"Our central forecast is for the Reserve Bank to start raising rates at the May 2022 MPS having brought the LSAP programme to its conclusion before then. We see the risks around these forecasts as being evenly spread between tighter earlier and a more protracted period of stimulus. We doubt very much the RBNZ would feel comfortable publishing such a view at this juncture but, in time, we believe this is what will happen." 

He notes that the biggest roadblock to an "aggressive RBNZ" is continued uncertainty.

"We are concerned that the current pace of expansion in economic activity is unsustainable and we still think the big hit from the international tourism sector’s demise is likely to show up over the coming six months."

And he says while all the talk, currently, is of the excesses in the housing market, "don’t forget this means the risk of a correction, and the economic shock that would bring, is rising by the day".

"The RBNZ will be particularly wary lest its actions act as the catalyst for such a shock. More generally, the RBNZ will not want to risk frightening the horses at this time."

Toplis says there is "some chance" the RBNZ announces modest tapering in the February 24 Monetary Policy Statement "but we doubt it will formally put an interest rate increase into a published interest rate track. However, the wording of the statement is likely to change to reflect the “new” environment and may even highlight the preconditions for rates to rise." 

Capital Economics sees the end of QE by the middle of this year

Capital Economics Australia and New Zealand economist Ben Udy thinks the RBNZ will end LSAP purchases "altogether by the middle of this year". 

"That would be consistent with the Bank purchasing a total of around $60 billion, or 45% of outstanding government bonds

"And we suspect a further rise in inflation and the continued tightening in the labour market will prompt the Bank to reduce stimulus further. The strength in recent economic data has brought markets around to our view that interest rates will be hiked in 2022. And we think the OCR will be tightened further to 1.0% in 2023.

"Given our view of policy tightening in the coming years, we expect bond yields to continue their recent rally."

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