The RBNZ Observer On hold this month

8 June 2011 For Immediate Release

The RBNZ Observer On hold this month: next hike Q4, says HSBC

Recovery in business conditions continues and inflation expectations are rising... ...nonetheless, we expect the RBNZ to remain on hold this week, awaiting further data on the quake’s effect. We still view the risks to inflation as to the upside and think that emergency policy settings should be reversed soon...but expect the RBNZ will hold until Q4

On hold for ‘some time’ Six weeks ago the Governor told us he expected rates to be steady for ‘some time’. We expect this to be the continuing theme this week. Since then we have seen further signs that the economy is staging a modest recovery. There are also some potentially worrying signs that inflation expectations are rising, with the RBNZ’s survey suggesting two-year-ahead expectations are at the top of the target band.

We remain of the view that the Kiwi economy is recovering and expect growth in 2H to be quite strong driven by a number of factors: what we have previously called, food, football and fixing the flatlands. These are: 1) meat and dairy prices are very high which are boosting rural incomes and encouraging investment in farm equipment; 2) the Rugby World Cup, which runs for six weeks in September/October, involves 85,000 visitors and is expected to boost the economy by around 0.5% of GDP; 3) rebuilding Canterbury (the flatlands) which is expected to start supporting the economy in 2H – the government is expected to spend NZD15 billion (8% of GDP) over coming years and some of that will start in the second half.

All in all, we think there are reasons to be confident that the second half will be much better than the first, and timely indicators suggest that an upswing has already begun. Given this, a key risk is that with inflation starting the upswing above the band (4.5%) – admittedly due to tax changes – and surveys showing inflation expectations are high, elevated inflationary expectations have become ingrained. In our view, this was always going to be a risk of using monetary policy to respond to a supply-side shock.

We still expect the RBNZ to remain on hold until Q4 and for rates to be lifted quite quickly through 2012 (to 4.25%) to keep inflationary pressures contained. Telltale hints in this week’s monetary policy statement of the RBNZ’s future plans for policy will be closely watched. Much like the March statement, we expect it will imply rates to rise from around the turn of the year, although the risk is that it is more hawkish.

The economy is recovering, when will rates? A number of indicators suggest that the Kiwi economy is staging a modest recovery and there are a number of factors to support growth in the second half: food, football and fixing Canterbury (as discussed above). The trade data, labour market stats and business surveys are all showing signs of recovery.

The trade data for April showed a surprising bounce, with the largest trade surplus on record, driven by a sharp rise in dairy exports. The very high level of milk and dairy prices driven by substantial demand from Asia and China in particular is the key story here. As we have long argued, as devastating as the Canterbury earthquake was, it did not have very much effect on dairy exports, which is a key driver of the current growth outlook.

Improvement in the New Zealand economy is also reflected in the labour market. Employment showed its largest rise in almost three years in Q1, taking employment back above previous peaks. The unemployment rate also declined and would have fallen by even more if not for a sharp rise in labour market participation – another sign of increased confidence. Since then, business surveys have indicated that employment intentions have improved and capacity utilisation is rising. Business confidence has also risen sharply following a temporary dip caused by the Canterbury quake (chart 1 below).

At the same time, a range of surveys have shown that inflation expectations are rising. The RBNZ’s own survey shows that two-year ahead inflation expectations have risen to the top of the RBNZ’s comfort zone (chart 2 below).

Bottom line

Rates are on hold this week.

We expect the post-announcement statement to be fairly benign but are on the look-out for plans of a more rapid exit strategy from emergency low rates.

We still expect the next rate hike in Q4.

Paul Bloxham, Chief Economist (Australia and New Zealand) HSBC Global Research Economics - Data Reactions 7 June 2011

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