Key Points
• The Kiwi economy is now running even further below potential. Growth in 2Q came in at 0.5% (Kiwibank 0.5%, consensus 0.4%), and just 2.1%yoy.
• The report was a little mixed, but broadly as we expected. The GDP report is old news. We know where we’ve been, it’s where we’re going that counts. And we all know the risks are not positive.
• What’s needed, is a strong fiscal policy. Monetary policy is proving ineffective without fiscal support. The budget is more important than the RBNZ’s MPS.
• The RBNZ decision next week is now in focus. We expect no change, but a cut in November to 0.75%. The risk of another move to just 0.5% is rising…

Growth has now slowed to a 6-year low, and downside risks are dominating. June quarter GDP growth came in at 0.5%qoq, in line with our expectation, and slightly above consensus. Although there were a few sensational reports of the chance of a negative print. The key point is annual growth fell to 2.1%yoy, well below potential of ~2.75%. The importance of potential is it offers us an estimate of where we should be running. And we should be running faster.

• The NZ economy expands 0.5% in the June quarter, in line with our and the RBNZ’s forecast. On an annual basis growth slowed to a 6-year low of 2.1%yoy and below trend for NZ.
• Services sectors carried the economy over the second quarter, lifting from a particularly weak start to 2019. In contrast, weaker commercial construction and manufacturing activity dragged on growth.
• On the expenditure side both public and private spending supported a 0.7% qoq lift in GDP. Investment and exports provided offsets.
• As is the case with GDP data, come release day and it’s already old news. More importantly for the RBNZ, is where growth goes to from here. We need above trend growth to generate domestic inflation.
• A continued lack of confidence from firms and households, combined with heightened uncertainty offshore, suggests forecast of strengthening growth may struggle to materialise. We expect that the RBNZ will be forced to act by further cutting the OCR to 0.75% in November.

What’s needed to snap us out of limbo, is strong, wise, and expansive fiscal policy. Central banks around the world, including the RBNZ, are calling for Governments to step up and do their part. Departing ECB president Draghi said last week, as he cut rates and restarted QE, that “Now is the time for fiscal policy to take charge”. And in New Zealand, we have no funding excuse. Funding is in ample supply, and done dirt cheap (to quote Australia’s hardest export, AC/DC). There’s nearly $17 trillion invested in government bonds with NEGATIVE interest rates. Those (predominantly foreign) investors would love to see more Kiwi Govies to buy at +1%. And we could issue +30-year bonds for international insurance companies, super funds and locals ACC and NZ Super. It’s not hard.

All eyes turn to next week’s RBNZ OCR statement
We expect the RBNZ to keep the OCR unchanged next week. But nothing is certain.
The decision to cut 50bps to 1% in August was the fast-forwarding of two cuts into one. So, we’re unlikely to ‘need’ another cut so quickly. Conditions haven’t deteriorated that much. But the balance of risks are clearly tilted to the downside, not up. The short September OCR announcement will leave us looking to the November MPS for guidance. We expect the bank to use the full forecasting round and time with the MPC in November to tack again. More wind in the sails is needed.
Has the OCR has troughed in this cycle?
No, unfortunately not. We’re anticipating another cut in November to just 0.75%. At which time, we will seriously consider adding another cut to our trajectory to just 0.5%. For now, we assign an uncomfortably high probability of a move to 0.5% at 40%. We said the same thing about a move to 0.75% in March of this year. So, the direction of change has been down, for too long now. What’s missing, is not monetary policy response, it’s fiscal. It’s high time for the Government to inject much needed investment.

Market Reaction
Interest rate markets were up about 3-4bps, on the slightly better news. The Kiwi flyer (NZD) is also higher. In our opinion, the GDP report doesn’t change a thing.
For next week’s RBNZ decision, we put the probability of no change at 70%. There’s still a 30% chance of a cut, which is high and reflects the environment we are in. The market has (5/25) a 20% chance of a cut priced into next week, and that’s about fair. November is priced at 0.8% (20/25), or 80% chance. Again, 80% chance feels about right.
The low point in the OIS (overnight index swap) strip is currently 0.62%. So assuming we’re right in getting to 0.75% in November, the market has another (13/25) +50% chance of a move to 0.5%. We’re currently at 40% and thinking of moving to 60%, so yeah, we wont argue. The severity of the bank capital requirements, to be determined later this year, will ultimately determine whether we’re likely to see even deeper OCR cuts, just to keep lending rates the same.

A full report will follow later today.

ends

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