Our Reserve Bank's entitled to feel frustrated with the delays over US interest rates because the ultimate decisions over there have an impact on its own decisions

By David Hargreaves

I'm sure he didn't, but Reserve Bank Governor Graeme Wheeler could have been forgiven for uttering a few choice Anglo-Saxon expressions early last Friday.

"Disappointed", I think might have been one milder word to bring out, providing it was used in the brilliant way that actor Kevin Kline unleashed it in the 1980s comedy classic A Fish Called Wanda.

The US Federal Reserve's decision not to make a decision on interest rates is not the first time our central bank has been 'disappointed' by it's very big brother half-way across the world.

There was similar vexation for the RBNZ back in 2013. Back then the Fed was heavily signposting a removal of its money-printing market support policies, but then it delayed.

At the time the RBNZ was battling a rampant Auckland housing market (sound a bit familiar?) and was very much of a mind to raise interest rates - but couldn't because the New Zealand dollar was riding sky high and a rise in rates would have been expected to take it higher.

A US move to more "normalised" monetary conditions was therefore seen as very important for getting our dollar down to what were seen a more realistic levels. But our central bank was left hanging by the dithering in the US. Eventually of course the Fed did get on the horse and begin cutting back on its Quantitative Easing, but now we've seen similar umming and ahing with the next step of the 'normalisation' process, an actual increase in US interest rates.

I formed a view many months ago that we wouldn't see US rates rise this year at all because global economic conditions would not allow it. I changed my mind and decided that the Fed would jump on Friday, not because I thought that they should but that the body language coming out of the US appeared to be "damnit, we need to normalise, ride that horse, yee-har!". Also, the Fed appeared determined to base its decision on US considerations - not what might or might not be happening in the global equation.

So, with the Fed suddenly throwing in said global economy as a reason not to move, I for one am not sure where the heck this leaves us. To me it would scarcely be credible for the Fed to now turn around next month, or even December and raise rates. But frankly, who knows. And I wouldn't exactly say the Fed's credibility is intact at this stage anyway.

I dare say that if the RBNZ was leaving the markets hanging the way the Fed has that it would be subjected to a torrent of criticism here. As one quick aside, I would suggest that those pushing for our rates to be set by committee (as opposed to the Governor, after extensive consultation with others) have a look at what's happening with the Fed, the disparate views emerging from it, and the blowing in the wind nature of its decision making - and possibly think again.

What the Fed did mattered in 2013 and it matters now in large part because of our currency. The RBNZ has spent recent years ripping its hair out at the strength of the Kiwi dollar but, finally, this year the naughty Kiwi has behaved and dropped markedly. Figures compiled by the RBNZ show that between April 22 and September 10 the Kiwi dollar devalued by 14.7% against the trade weighted index of 17 of our trading partners and lost a whopping 18.2% of value against the US currency.

Dollar stabilises

But in recent days there's been signs of stabilisation and of course on Friday our dollar lifted considerably against the US - though there will have been some satisfaction in central bank quarters that the Kiwi has started this week in somewhat softer fashion.

The current expectation is that the RBNZ has one more drop of the Official Cash Rate to do in this cycle (which would take it back to the 2.5% it was at last year before the bank hiked rates up to 3.5%.) The RBNZ has clearly wanted to leave itself with some thinking space about when that final drop to 2.5% takes place. It seemed to me that the RBNZ was looking for a 'pause' with its next OCR decision in October and then maybe making the drop in December - by which point of course everything would be clearer in the US.

Or not. As it turns out.

If the Fed keeps dithering and delaying I think there's got to be at least a chance that the Kiwi dollar starts to actually climb again. And I feel as a non-economist layperson comfortable making that suggestion because I've looked at bank economists' predictions of the currency over the past 18 months and found them generally as reliable as those of horse racing pundits picking through a form guide. It's a bit of a lottery, let's face it.

Looking for inflation

But the the thing is, the RBNZ's expecting that inflation will start to come through from the falls we've seen in the currency, helping get inflation back somewhere toward its explicit target of a 2% rate (being the mid-point of the official 1-3% targeted range). There is of course something of a debate now about whether the traditional pattern of a lower currency feeding quickly and strongly into higher prices is still a given in an increasingly internet-dominated world. But whatever your view on that one, there's no doubt a newly resurgent Kiwi dollar could put a crimp in the inflation picture - IE the RBNZ would continue its recent long run of undershooting its inflation target.

That's why I still don't think you can rule out the possibility the RBNZ may be forced into pushing the OCR below that perceived floor of 2.5% and to new record lows early next year. The RBNZ, in what seemed a reaction to some bank economists picking lower rates (and Westpac's been at the forefront) said rather sniffily that an OCR under 2.5% would indicate an economy in recession. Several bank economists have hit back to say that wouldn't have to be the case at all, and the RBNZ itself in its most recent Monetary Policy Statement examined an alternative scenario that saw the OCR falling to 2%.

The emerging wild card now is the sudden resurgence of dairy prices, albeit that this seems largely based on expectations of fairly meaningful cuts in milk production. Whether the rises we've seen so far would change the RBNZ's central view is debateable, but further significant rises in say the next couple of dairy auctions likely would.

A ticklish decision

All of which leaves the RBNZ's next rates decision on October 29 being a pretty ticklish one. There's another slight complication. The Fed's next decision on rates will be released just hours before the RBNZ has to make its 9am announcement here (who worked out that timing then?). Logic would suggest that if the RBNZ takes what the Fed said in its statement last week literally it would likely take the view that there will be no change again. I certainly read the statement as very 'dovish'.

Therefore it might be as well if our central bank takes the plunge and drops rates to 2.5%, in an attempt to head-off a rally in the Kiwi currency that may well occur if the Fed's new decision is another non-decision.

But then of course, the RBNZ may prefer to wait and see. The problem with that though is that the Fed's last decision for the year will be announced here on December 17 - which is after the RBNZ's last OCR decision for this year on December 10. If the RBNZ then does get caught in wait-and-see mode, and if the Fed really doesn't raise rates this year then theoretically our central bank might not be able to put that 'last' rate cut in place till the first rates decision of next year in late January. At least of course it would be as reasonably soon as January. From next year the RBNZ's planning to have a three-month break between decisions over summer, which I reckon is going to prove to be unwise.

So, anyway, all things considered, it might appear sensible for the RBNZ to have another cut next month and not wait. But I won't be betting on that.