The RBNZ Observer

27 April 2011
For Immediate Release

The RBNZ Observer

On hold for a while: expect next hike in Q4

Recent data shows modest recovery before the quake …
… and quake weakness largely isolated to Canterbury region
With inflation elevated, the RBNZ is expected to highlight the role of high commodity prices and indicate that rates will rise when ‘rebuilding begins’

On hold for a while

After last month’s nail biting rates decision, this month is expected to be a doddle. Market economists are universally convinced the RBNZ will be on hold at 2.50% – emergency lows. We agree. As the RBNZ pointed out last month, they expect to be on hold ‘until
rebuilding begins’.

We expect rebuilding from H2 and an RBNZ hike before year-end.
The run of data over the past six weeks has provided further evidence that a modest recovery was underway before the late February quake. To start with, GDP in Q4 2010 rose by 0.2%, a bit stronger than expected.

While little data post-dates the earthquake, what has been published is somewhat reassuring. Electronic card transactions data – a timely guide to retail sales – rose in March, despite the quake occurring in late February. And while business confidence has fallen, it is only back at two-year lows, and in some of the more timely surveys has bounced back subsequent to the quake. Surveyed activity indicators also suggest that the weakness is concentrated in Canterbury. The NZIER survey of trading activity suggests that the economy excluding the Canterbury region was steady.

This is consistent with our view that, while the earthquake was a tragedy, the economic effects are likely to be fairly geographically concentrated (The RBNZ Observer, 8 March The RBNZ Observer On hold for a while: expect next hike in Q4/2
2011). Indeed, while Canterbury is 15% of the economy, almost two thirds of the region’s economy is agricultural, which has lost little productive capacity as a result of the quake.
Suffice to say, while around 6% of the economy – mainly Christchurch – was severely affected, the rest of New Zealand was already recovering when the quake struck.
Looking forward, very high milk and meat prices are expected to boost incomes and investment over coming months and emergency low interest rates should boost the housing market. Next month’s budget will also no doubt contain measures to assist Canterbury, in addition to the automatic fiscal response from the Earthquake Recovery Commission. Add to this that inflation is already above comfortable levels and we think the RBNZ will lift rates at the first sign of recovery from the quake.

Inflation elevated and commodity prices high

Q1 inflation was published during the month and showed that inflation was still above target. Headline inflation rose by 0.8% in the quarter and by 4.5% over the year. Inflation was partly held up by the effects of tax changes in October 2010, which were still flowing through to the numbers, but it remains the case that inflation is above the RBNZ’s comfort zone. In addition, non-tradables inflation – which is a good guide to domestic inflationary pressures – was strong, rising by 1.1% in Q1 and by 5.2% over the year: its highest rate in over a decade.
While the various measures suggest that inflation expectations remain contained, we expect that the RBNZ will want to lift rates in the direction of neutral sooner rather than later. Of course, somewhat assisting the RBNZ in maintaining inflation stability is the high level of the NZD. In a recent speech the RBNZ Governor noted that the flexible exchange rate plays an important role in the economy, somewhat dismissing market concerns about intervention in the exchange rate market by the RBNZ. However, in the same speech he also highlighted that if the high level of commodity prices and the exchange rate leads to greater spending on consumption and investment, it may put pressure on inflation and would require a monetary policy response. It is clear that this will be the next concern for the RBNZ. The RBNZ Observer On hold for a while: expect next hike in Q4/2
Bottom Line

Rates are on hold until later in the year.

Our read of the economy is that recent data shows a recovery was in progress before the quake and that while the quake had a significant effect on Christchurch, the broader economy has been firming.

We expect the RBNZ to highlight the role of commodity prices in the outlook for New Zealand’s monetary policy and reiterate that rates will need to rise when rebuilding begins.

We still expect the next move in Q4.
ends

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