Governor flags hike due soon: HSBC now calling 3Q

28 July 2011

RBNZ Observer Update
Governor flags hike due soon: HSBC now calling 3Q

•RBNZ kept rates steady today, as was widely expected ...
•... the Governor gave a strong signal that rates need to rise soon, flagging that the RBNZ sees ‘little need’ for the ‘insurance’ cut to remain in place much longer ...
•... we now expect the next hike in September, with rates still expected to rise by 175bps over the next 18 months

RBNZ kept rates steady today at their emergency low, of 2.50%, as was expected.

The Governor gave a strong indication that rates will need to rise soon, flagging that the RBNZ sees ‘little need’ for the ‘insurance’ cut to remain in place much longer.

Much as we expected, global uncertainties seem to have kept the RBNZ sitting on their hands today: lifting rates at a time when global financial markets are dislocated is tricky.

As we have long argued, we think the March rate cut was a mistake and that cutting rates was the wrong response to a negative supply shock. Negative supply shocks typically drive inflation up, not down.

The RBNZ today acknowledged that the cut was an ‘insurance’ policy, presumably against the possibility that the earthquake severely reduced demand, via weakened confidence. But, as we all know, insurance costs something. This cost may be that rates need to rise more and faster than otherwise to get inflation expectations under control.

Today’s statement sought to condition inflation expectations by pointing out that underlying inflation was below 2.5%. But with headline inflation at 5.3% and rates at emergency lows, this effort may require action, rather than words. We still think that inflation and inflation expectations are uncomfortably high and that the risk is that the
RBNZ is already behind the curve.

Of course, the current strength of the exchange rate is doing some of the work for the RBNZ. The Governor acknowledged today that the high NZD is ‘acting as a drag’ on the economy and that if this persists it may reduce the need to OCR moves in the ‘short term’.

The key caveat to all of this, of course, is that global financial markets do not see a significant meltdown, which we view as a very small risk. The RBNZ acknowledged this in today’s statement, suggesting that removing the ‘insurance’ cut would occur on the proviso that ‘current global financial risks recede’.

Bottom Line

RBNZ remained on hold today, but gave a strong signal that rates will need to rise soon.

As a result, we now expect the next hike to be in September, with another hike in 4Q and a total of 175bps of rate rises by end-2012.

ENDS

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