On hold for now, but growth is picking up

The RBNZ Observer: On hold for now, but growth is picking up

- Inflation is currently low, as it has been held down by a high NZD; but, looking forward, we expect inflation to rise, given strengthening local growth and the recent fall in the NZD

- With domestic indicators surging in the past couple of months, we have revised up our GDP growth forecasts for 2013 to 3.0% (from 2.9%) and for 2014 to 2.8% (from 2.6%)

- We expect RBNZ to be on hold next week, but the next move is likely to be up and may come around year-end

Inflation low, but likely to have troughed

New Zealand’s inflation remained low in Q2, with CPI rising by only +0.7% y-o-y, a touch below the market expectation (+0.8%). With inflation still below the bottom of the target band (1-3%), we expect the RBNZ to be comfortable with rates on hold this week. There is little debate about this and the more interesting question for New Zealand is when will rates have to rise? In New Zealand’s case, this is important at this moment, as a number of forces suggest that Q2 may mark the cyclical trough for inflation.

Key to this is that the local economy continues to build momentum. The post-earthquake rebuild in Canterbury has started in earnest and is huge. Low interest rates are lifting the housing market, with Auckland housing prices now having risen by 20% y-o-y and rising inward migration likely to provide further support. Buoyant conditions are being reflected in the business surveys, which point to broad-based growth through the middle of the year, and in the consumer survey, where confidence is also rising. Reflecting improving economic indicators and a lower NZD, we are revising up our growth forecasts – we now expect GDP growth of 3.0% in 2013 (up from 2.9%) and 2.8% in 2014 (up from 2.6%).

Importantly, for the RBNZ, a key factor that had been holding down inflation – the NZD – has also shifted in direction. Indeed, since the RBNZ released its June official statement, the most significant development has been a sharp fall in the NZD. The NZD TWI has fallen -6% since its recent peak in April, to be -4% below the RBNZ’s June projections.

The fall in the NZD is expected to see tradable inflation rise. With the New Zealand economy already operating at close to capacity, it is likely to hit supply constraints soon, also lifting non-tradable inflation.

While low current inflation should keep rates on hold next week, we expect the RBNZ may need to contemplate lifting rates soon, perhaps as early as year-end.
ends

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