Cash rate steady, but statement hawks up

The RBNZ Observer Update
Cash rate steady, but statement hawks up

Six weeks have gone by and the Governor has shifted his tone from rates are on hold for ‘some time’, to rates are on hold ‘for now’. What will another six weeks bring? The statement acknowledges continued recovery and that the negative effect of the quake on the rest of the economy outside Canterbury has been limited (themes we have built for a while). While noting the recent weaker global data, they also point out that commodity prices are very high, boosting the economy. The case is building for a reversal of emergency rate settings. We still expect the next hike in Q4, but the risk is for an earlier move.

Facts
- Cash rate held steady today at 2.50% (emergency lows).
- RBNZ has acknowledged that the negative effect of the Canterbury quake on economic activity outside that region has been limited.
- They expect GDP rose modestly through the first half of 2011, despite the quake.
- RBNZ forecasts GDP rose by 0.3% in Q1 and 0.4% in Q2 – much like HSBC’s forecasts for 0.3% in Q1 and 0.5% in Q2. We expect stronger growth in the second half though, for a 1.7% y-o-y rate versus RBNZ at 1.2% (an upward revision from 0.9%).
- RBNZ still expects a significant rise in GDP in 2012 (4.4% Q412/Q411) – we do too.
- RBNZ inflation forecasts are largely unchanged, with CPI expected to be 4.5% in 2011 and 2.0% in 2012. We expect stronger inflation in the out year (3.0%).
- RBNZ noted the rise in inflation expectations, but is of the view that there remains significant excess capacity in the Kiwi economy that will keep underlying inflationary pressures at bay. We are less sure.
- The 90 bank bill profile underlying the forecasts is largely unchanged for this year (3.0% by Q4 2011) and revised up by 21bp for end 2012 to 4.55%. So they continue to imply a rate rise is likely by Q4 and now suggest around 175bps of hiking over the next 18 months – same as us.

Implications
The recovery is on and rates are still at emergency lows. What does this mean? Rates will need to rise and probably some time soon.

If the pace of change in the RBNZ Governor’s rhetoric is anything to go by, emergency settings may be reversed sooner, rather than later. Six weeks ago he told us rates were on hold for ‘some time’, now it’s ‘for now’. Is the next step ‘no longer’? Today’s statement certainly firms up our view that rates will rise in Q4, and the risk is that it happens sooner.

But don’t get ahead of yourselves. Last time the RBNZ was pre-emptive they regretted it. Today’s statement virtually acknowledged as much. Second sentence of the overview tells us that at the time of the March statement ‘economic activity had undershot the Bank’s forecasts for some time, and just as signs of recovery were emerging, Christchurch was struck by another devastating earthquake’. So the RBNZ may be a little gun shy this time around.

The more medium-term outlook also sees a number of rate hikes, which should make for interesting times in 2012. RBNZ’s underlying assumption for 90 day bank bills broadly aligns with our call for 175bps of tightening by Q4 2012.

RBNZ acknowledges the recent weaker global data but, very importantly, points out that the major channel for the world’s effect on the Kiwi economy is through commodity prices which are at high levels. This is boosting incomes, investment spending and confidence.

The statement forecasts also show that the RBNZ does not expect any negative GDP results as a result of the Canterbury earthquake. Q1 is 0.3% and Q2 is 0.4%. It seems weakness in Canterbury is expected to be largely offset by strength elsewhere. This is a theme we have been running for quite some time (RBNZ Observer, 8 March 2011). In essence, about 5% of the Kiwi economy was severely affected by the February quake, the rest of the economy was already in recovery mode.

And of course the economy will get a boost from rebuilding. Such is the typical pattern observed following a negative supply shock. The RBNZ expects rebuilding in Canterbury to boost the economy by 2ppts in 2012.

An interesting medium term question will be whether a rate cut was the right response to a negative supply shock. It typically isn’t. The cost may be uncomfortably higher inflation.

Bottom Line
A bit more hawkish than the market expected.

Many of the themes are ones we have long been building – essentially that the Canterbury quake’s effect would remain largely contained to that region. Particularly interesting that, like us, RBNZ has GDP forecast to rise in Q1 and Q2.

Still expect next rate rise in Q4, but the risk is for an earlier move. Also still have in mind rates rise 175bps by Q4 2012.

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

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