RBNZ Observer Update: Global risks

PRESS RELEASE

15 November 2011

For immediate release

RBNZ Observer Update: Global risks to delay emergency withdrawal

Rates are still at emergency lows in New Zealand...
...but global risks will likely keep them on hold for longer than previously expected
We still expect the next move is up, but not until Q1 2012

Global risks more prominent

The crisis in Europe has continued to punish financial markets and has kept policymakers on edge. Concerns are now moving east, with the possibility that a European banking crunch could spill over into Asia. Growing uncertainty about the global outlook has kept the RBNZ on hold in recent months, and with global problems looking as though they will persist for some time, we expect these will delay the RBNZ’s previous plans to head back towards neutral.

While domestic indicators have generally been positive in New Zealand, there are also some signs that global financial woes are creeping into sentiment indicators. In particular, the PMI and PSI have fallen in the past couple of months. The PMI is now below its break-even level, at 46.5, in October, down from 50.8, and the PSI has declined to 50.6, down from 53.2. This could partly reflect that activity was disrupted by the Rugby World Cup, but also reflects reduced confidence due to global concerns.

Our view remains that there are a number of significant structural factors that will support growth in New Zealand over the coming year or so – including the just concluded Rugby World Cup (in the short term) and the reconstruction of Canterbury and the high level of commodity prices (in the medium term). However, as global risks have become more prominent, it seems less likely that the RBNZ will withdraw its emergency policy setting rapidly. Indeed, while yesterday’s retail numbers for Q3 rose by a strong 2.2%, due to spending as a result of the Rugby World Cup – which will likely provide significant support for Q3 GDP growth – we expect weaker sentiment indicators will keep the RBNZ on hold next month.

With rates still at emergency levels, we still think the next move is up, and we also expect that rates will need to rise well ahead of current market pricing – which currently has a measly 14bps priced in over the next year.

We now expect the next move to be in Q1 2012 and rates to rise by 100bps by end-2012.

Upswing in progress, but more modest than expected

Recent indicators for New Zealand have generally been a bit weaker than expected. Yes, Q3 retail sales got a boost from the Rugby World Cup, but the unemployment rate seems to be stubbornly high, at around 6.5% in Q3. The monthly PMI and PSI surveys have also been weak in October. To some degree, this may reflect a temporary disruption due to the Rugby World Cup, but it could also reflect some weakening in confidence due to global financial turmoil.

These indicators beg the question: is the economy heading into a downswing? We do not think so. The fundamentals for New Zealand still look good. Commodity prices are still at high levels, reflecting marginal demand for dairy and meat – New Zealand’s key exports – coming from the emergence of China’s middle class. The reconstruction of Canterbury will also boost the economy next year, and it is pre-funded, and as such, does not rely particularly on the global environment. Finally, with rates still at emergency lows, households and businesses are getting a boost from loose monetary policy, particularly given that most housing mortgages are now at variable rates.

While inflation has been a bit lower than expected, it is still elevated. Stats NZ estimates suggest that headline CPI ran at 2.5% when they abstract from the impact of last year’s tax changes, which still means that inflation is in the upper part of the RBNZ’s target band. The exchange rate seems to have kept inflationary pressures at bay thus far, though the recent depreciation will see some of this downward pressure abate over the coming period.

Bottom line

Global financial turmoil combined with weaker recent domestic indicators suggests the RBNZ will be on hold for longer than previously expected.

We now see the next hike in Q1 2012, with rates rising by 100bps over 2012.

See attached press release for more details

See attached press release for more details

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