RBNZ Observer Update

RBNZ Observer Update: On hold, but rates may need to rise soon

The RBNZ left its cash rate unchanged at 2.50%, as expected. Stronger inflation pressure has seen the central bank revise up its projections for 90-day rates, with the RBNZ now expecting to lift rates in H1 2014. With inflation pressures rising, the RBNZ noted that ‘OCR increases will likely be required next year’ although they once again stated that they ‘expect to keep the OCR unchanged in 2013’, partly reflecting the headwind to growth from the ‘high’ NZD. We expect the RBNZ may need to lift rates around year end. This could come as soon as later this year, though the RBNZ sees it as more likely to be early in 2014.

Facts
- The RBNZ left its overnight cash rate unchanged at 2.50%, as expected.

- With the economy picking up and likely to see higher inflation, the RBNZ noted that ‘OCR increases will likely be required next year’. However, with a high NZD still a headwind for growth, and inflation still low in Q2, the RBNZ continued ‘expect to keep the OCR unchanged in 2013’.

- The central bank has revised up its projection for 90-day interest rates by around 50 basis points, with the profile now pointing to rate hikes in H1 2014.

- The RBNZ is assuming recently imposed loan-to-valuation restrictions on the mortgage market will take around 2.5 percentage points off annual house price inflation and took 30 basis points off the outlook for 90-day rates.

Implications
With inflation still below the RBNZ’s target band in Q2, the central bank had room to keep rates on hold at 2.50% at today’s meeting. However, at the same time, the central bank has revised up its outlook for 90-day interest rates, as the New Zealand economy continues to build momentum, the NZD has eased from highs, and broader inflation pressures have increased.

The RBNZ projects the economy to grow at an annual pace of around 3% over the next year (similar to our own view). Low policy rates, momentum in the housing market, an increase in export prices and the boost provided by the post-earthquake rebuild in Canterbury are expected to support growth. Somewhat offsetting this, the high NZD is still seen as a key headwind, despite its recent declines. Business surveys have increased strongly in New Zealand in recent months and point to upside risks to the central bank’s growth projections over the second half of this year.

On the inflation front, the RBNZ projects a gradual increase toward the centre of the target band through 2014 and 2015. Two key inflation risks are highlighted in the statement. The first is the potential for stronger spillover from the rising housing market into general inflation. In this regard, the bank is expecting the recent imposition of loan-to-valuation (LVR) restrictions on the mortgage market to help. The RBNZ’s central projection assumes annual house price inflation is 2.5 percentage points lower than otherwise – with the policy taking 30 basis points of the 90-day rate track, all else equal.

The second risk is that the momentum in the construction sector, particularly in Canterbury, spills over into broader inflation pressure.

We see upside risks for these two key elements of the RBNZ’s projections. In our view, the imposition of LVR restrictions is unlikely to have a significant impact on the housing market. In addition, the strong housing market already looks to be spilling over into the broader economy, with household spending getting a boost.

Further, construction cost inflation already looks to be running ahead of activity in the sector. Quarterly construction cost inflation has reached levels seen during the 2000s housing boom, and this is likely to spillover from Canterbury to the broader construction sector in coming quarters.

Overall, inflation is likely to pick up solidly from here. The domestic economy is strengthening, the housing market is likely to remain strong and a lower NZD will no longer provide the dampening impact on tradable inflation that it has in the past.

As such, the RBNZ’s next move is likely to be up, and the central bank may need to lift rates around year end. The question is: when? Our central case remains that the RBNZ lifts rates in Q4 this year, though clearly the risk is for an early 2014 move, given the RBNZ’s own commentary.

Bottom line
The RBNZ kept rates unchanged at 2.50% as expected.

The central bank revised up its outlook for 90-day interest rates, with rate hikes now implied by H1 2014.

Our central case remains that the RBNZ lifts its cash rate in Q4 this year, though clearly the risk is for an early 2014 move, given the RBNZ’s own commentary.

All eyes will be on next week’s Q2 GDP print and the mid-October Q3 CPI print.
ends

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