RBNZ is watching the world, not the Rugby

15 September 2011

RBNZ Observer Update

With the World Cup in full swing the RBNZ staff should be busy watching the games, but instead, like the rest of us, they've been glued to their Bloomberg terminals. With global markets in disarray, it was no surprise that the RBNZ kept rates on hold today. The Governor reminded us that, purely on domestic grounds, the RBNZ would be hiking, but that concerns about a possible weakening in demand for exports and increase in bank funding costs were enough to keep them benched, for now. RBNZ is clearly in wait and see mode on global scene, but with a bias to tighten. We still expect rates to rise before year-end.

Facts
- RBNZ left rates on hold today at 2.50%, as expected.
- The economy has picked up more rapidly than the RBNZ had expected. They now have in mind that GDP growth was 1.8% y-o-y to Q2, up from a forecast of 0.7% in the June official statement.
- The RBNZ still expect CPI inflation to fall to the middle of the RBNZ's target band by Q2 2012, even though measures for one-year ahead have inflation expectations remaining around the top of the target band.
- The RBNZ's forecasts for the 90-day bank bill have only been revised down a touch. By end 2011 they now expect them at 2.9% (down from 3.0% in the June statement) and 4.3% by end 2012 (down from 4.6% in the June statement). Taken as a read of RBNZ policy expectations this would suggest one 25bp hike this year and another 125bps next year.
- RBNZ forecast their export commodity prices to remain high and also noted that climatic conditions in New Zealand had been very favourable in 2011, both of which are expected to support export earnings.
- And they expect to be lifting rates, unless the global scene gets a whole lot worse. 'If the recent global financial developments have an only mild, but not severe, impact on New Zealand, it is likely that the OCR will need to be increased over the coming year or so.'

Implications
Leaving rates on hold today was widely expected, given the current state of global financial markets and the potential implications for global growth.

The RBNZ is clearly gaining confidence that the New Zealand economy is now in a solid domestic upswing and this rings true through their official statement.

They have been surprised by the strength of the upswing, with their new estimates for y-o-y GDP growth to Q2 more than double the pace they expected only last quarter. This mostly reflects history, with the upside surprises coming in the Q1 numbers.

The statement points out the key drivers of growth are in place, with commodity prices high, weather conditions favourable, the Rugby World Cup boosting activity this year and the repair and reconstruction Christchurch largely yet to come.

Despite this outlook, they are still quite sanguine on inflation.

They still expect inflation to head to the middle of the target band by mid-2012, despite elevated inflation expectations and the high starting point.

They do note, in particular, that the high level of the exchange rate will help to dampen inflationary pressures. They expect the trade-weighted index to remain over 72 (which is around its highest level in a decade) over the rest of the coming year.

The RBNZ's forecasts also assume that rates rise from here, with around 25bps factored in this year and another 125bps next year.

Clearly much is dependent on global developments. The RBNZ will have little appetite to be lifting rates with the global financial markets in disarray.

Bottom line
Global uncertainties kept the RBNZ on hold today, as expected.

We still expect rates to rise before the end of the year, fully reversing the emergency cut, but global developments are clearly a downside risk to this outlook.

ENDS

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