RBNZ Preview: Rate Hike Followed by More Rhetoric

RBNZ preview: rate hike followed by more hawkish rhetoric

JPMorgan expects the RBNZ to hike the official cash rate (OCR) to a fresh record high of 8.25% tomorrow morning. The expected rate hike is a result of a stronger than anticipated nontradables inflation outcome in 2Q; the CPI result came on top of cumulative RBNZ frustrations over relentless house price appreciation, fiscal policy largesse, elevated levels of retail spending, the pass-through effects from surging dairy prices, and measures of capacity constraints (from the latest business surveys) that remain uncomfortably high. In light of recent developments, it appears the RBNZ's war on inflation is not over, and another OCR tightening is warranted.

Already, the RBNZ has raised the OCR three times this year in order to encourage a lower inflation trajectory - hawkish public commentary indicates that officials have sufficient determination to go further. The RBNZ's assertiveness in responding to upside surprises on key economic data has intensified this year. RBNZ officials seemingly have become more comfortable with the risk of possibly overtightening at the end of a tightening cycle that already has spanned four years—the RBNZ started tightening policy in January 2004, and has since raised the cash rate 12 times.

Watch the wording

Due to the fact that we are nearing the end of this tightening cycle, the RBNZ intentionally has left out forward looking commentary from its last two statements (April and June) - future policy moves have become data-dependent. The most likely outcome tomorrow is that the RBNZ will explain the reasoning behind the last 'four' rate hikes with similar wording to that used in April and June.

June: "Had we not increased the OCR this year, it is likely that the inflation outlook would now be looking uncomfortably high. This further increase in the OCR is to ensure that inflation outcomes remain consistent with achieving the target of 1 to 3 percent inflation on average over the medium term."

April: "There has already been a recent rise in fixed mortgage interest rates. This further increase in the OCR is aimed at ensuring that inflation outcomes remain consistent with achieving the target of 1 to 3 percent inflation on average over the medium term."

Intentionally leaving out forward-looking commentary enables the bank to be non-committal on further rate hikes, and keep market expectations focussed around upcoming data.

Should they decide, however, to include a forward looking statement - officials probably will leave the door open for the possibility of yet another rate hike should the data surprise on the upside. The language could be along the lines of what officials said back in January and December indicating that in the absence of clear indications of a moderation in housing and domestic demand, further policy tightening 'may' be required (or cannot therefore be ruled out). And the RBNZ may also wish to note that - "Any easing of policy must remain some considerable way off" (December MPS).

Either way, the commentary will remain hawkish. Alternatively, a tightening followed by neutral commentary would help ease upward pressure on NZD (something all exporters and the Government would enjoy), but potentially would mitigate the desired impact of Thursday's tightening on the economy.

Probability of a second tightening in October is rising

The RBNZ's hawkish June MPS hinted that further tightening may be required. With this in mind and, even after assuming that the RBNZ will tighten tomorrow, there is a growing risk of another tightening in September or October. Further tightening depends on whether key data-points show decisive signs of turning in the third quarter. JPMorgan believes there is over 20% chance of a further tightening in September but, due to the top-tier data released between September and October (CPI, GDP, and NZIER QSBO), the probability is higher for October at 30%.

The RBNZ's scenario analysis for short-term market interest rates in the latest MPS showed a higher "alternative scenario" that predicted a 90-day interest rate track peaking at 8.5% in 4Q, above the 8.3% in the central projection. The central bank's alternative scenario was based on an economy that is "more stretched," in which "world dairy prices prove to be higher for longer" than the central projection. These factors appear to be playing out, with 1Q GDP coming in ahead of RBNZ expectations (at 1.0%q/q versus a 0.8% forecast), capacity utilization levels remaining elevated, nontradables inflation still holding at uncomfortably high levels, and dairy prices continuing to soar.

Please find our RBNZ preview note from GDW attached.

ENDS

See... RBNZ preview note from GDW (PDF)

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