No rate hike, but hawkish commentary a must

No rate hike, but hawkish commentary a must

The RBNZ will deliver the June Monetary Policy Statement this Thursday - JPMorgan expects the RBNZ to leave the official cash rate (OCR) unchanged. Although the OCR is likely remain at 7.75%, the RBNZ will use the MPS to justify its last two rate hikes (in March and April) by mentioning the recent economic developments, which included an array of data surprising on the upside. Moreover, the forward-looking rhetoric will be hawkish - the last policy announcement did not include guidance on the policy outlook - so the RBNZ will fill this void.

Why the RBNZ will remain on hold this Thursday:

Having just tightened policy 50bp in the last two rate announcements (25bp a piece), Governor Bollard is likely to pause and assess developments before considering any further tightening. The RBNZ finally has received bang-for-its-buck, as mortgage rates spiked higher over the past few months, not only on the back of the two tightenings, but moreso in response to firm warnings to domestic banks by Governor Bollard in the weeks after the last rate hike. The majority of stronger than expected data to date is for months prior to the RBNZ's last rate hike and the subsequent spike in mortgage rates;

Anecdotes from real estate spivs are starting to suggest that the recent spike in interest rates is beginning to bite. Although this still may take some time to show up in the housing related data, and a few more months to illustrate a sustained downward trend, it would be prudent to see if the recent drop in confidence feeds through to a reduction in activity; and

Both consumer and business confidence have buckled under the weight of higher interest rates, and the outlook is fast turning from one of blue skies to violent tempest. According to the latest Colmar Brunton poll, consumer confidence fell for a third month in May, as 39% of respondents expect the economy will get worse in the next 12 months (up from 38% in April and 36% in March). More worrisome, however, was the plunge in last week's NBNZ business confidence survey. In May, a net 48% of businesses surveyed expected business conditions to deteriorate over the coming year, down 29 points from April. Declines in sentiment were recorded across all sectors, the largest being in the agricultural sector, which dropped 69.9 points. The drop in business sentiment largely reflects the appreciation on the currency which is being driven by high local interest rates. The shear size of the fall in confidence (business activity expectations especially) over the month mirrors that seen prior to past recessions.

Why a strong tightening bias will be enforced:

Down but not out. The New Zealand economy has shown great resilience and immunity to an increasingly impotent monetary policy. Over the past three years, the RBNZ has hiked policy eleven times with a mind to tame an overheated housing market and to rein in the beast that is inflation; but after each bout of tightening the economy merely slowed (and even stalled in 2H 2005) before bouncing back with a vengeance. Local banks were partly to blame, as a prolonged mortgage rate war reduced the margin between the OCR and the effective mortgage rate - effectively nullifying much of the monetary policy impact;

The other source of frustration to the RBNZ is the conflicting loosening in fiscal policy by a Government that is flush with cash and behind in the opinion polls. Although the recent budget was masked as 'fiscally prudent' (especially given the windfall of tax receipts over the past year), the sizable increase in the fiscal impulse (i.e. looser policy) continues to work against monetary tightening. This is a problem that remains front of mind to an RBNZ transfixed on inflation pressures emanating from an economy working at full capacity;

Non-tradeables inflation remains uncomfortably high. From the RBNZ's viewpoint, non-tradeables inflation (inflation emanating out of the domestic economy and not influenced by the exchange rate) was running back above the psychological 4%oya level at 4.1% in 1Q, and has only fuelled the RBNZ's frustrations over its inability to break the inflation beast's back. Until non-tradeables inflation is well and truly tamed (back below 3%oya) a bias to tighten policy will remain on the table.

A slew of stronger-than-expected data of late - including retail sales, net migration, and house prices - have heightened the need for a vigilant tightening bias to be maintained. That said, most of the upside surprise to the data occurred in months prior to the last two RBNZ rate hikes; and

The RBNZ has cited four key reasons for the last two interest rate increases. 1.) the strong housing market, 2.) the Government's fiscal largesse, 3.) ongoing net migration, and 4.) a robust labour market. These four concerns remain current.

ENDS

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