Data Flash (New Zealand)
Key points
The RBNZ increased the official cash rate (OCR) by 25 bps to 5.50% when it released its quarterly Monetary Policy
Statement.
The market had priced a 30% chance of a 50 bps move and acting RBNZ Governor Carr said that a 50 bps hike could have
been justified.
The relatively hawkish tone of the Statement was also reflected in the upward revision of the RBNZ's path for 90 day
interest rates, which are now projected to reach 7% in early 2003 (compared to 6.25% in the March forecasts). That
projection confirmed the aggressive pricing of the forward track that has been a feature of the NZ market over recent
months.
However, the Bank qualified the 90 day rate projection by noting that a continued stronger than expected NZD performance
may take pressure off interest rates. The Bank projects the TWI to average 53.5 over the second half of this year and
54.75 in H1/2003. The TWI was at 54.3 today.
The RBNZ's Statement continues to reflect concerns about the pace of demand growth, which is seen as putting pressure on
resources and preventing a decline of CPI inflation into the mid-part of the 0-3% target range.
The RBNZ acknowledges that consumption growth will slow as farm incomes fall and inward migration returns to more
sustainable levels. However, the Bank concluded that slowing demand growth has to be reinforced by the withdrawal of
interest rate stimulus and, subsequently, a move beyond the `neutral' rate. The RBNZ estimates that the neutral OCR is
around 6%.
Acting Governor Carr noted that underlying inflation is currently around 2.5%. The Bank sees an increasing risk of an
upward adjustment to inflation expectations.
Given the underlying projections for the real economy, interest and exchange rates, the Bank expects inflation to fall
to around 2% by early 2003. That track is marginally higher than the one published in March (see chart).
Initial market reaction
The bill curve steepened, with the front 90 day bill contract rallying 3 bps, while the 2nd and 3rd contracts were off 2
and 8 bps respectively.
Short bonds sold off around 7 bps, while 10 year yields were unchanged.
The NZD rallied by around 20 points to 0.4580.
Our assessment
In its April statement the RBNZ noted that the data since the March MPS had evolved broadly as expected. The same can be
said for the data flow since April. Nevertheless, the RBNZ has become more concerned about the inflation outlook, which
is even more surprising in the light of the significant appreciation of the NZ dollar over the past few months. As a
result of this re-assessment, the Bank's view of the likely peak of the interest rate cycle has shifted up by 75 bps.
This apparent inconsistency in the RBNZ's interpretation of economic trends can be attributed to a change in the
composition of the Bank's policy committee and the departure of the previous Governor, Dr Brash. Acting Governor Carr is
seen as more `hawkish' than his predecessor, while most of his advisors are at the `hawkish' end of the spectrum.
Despite these personnel related influences on the RBNZ's thinking and decision-making, we maintain our central call that
the RBNZ will not step up the tightening pace over coming months. We expect OCR increases of 25 bps increases on 3 July
and 14 August. Furthermore, we do not agree with the RBNZ that the tightening cycle will reach 7%. Our own forecast has
the OCR peaking at 6.5% in early 2003.
While the market in currently pricing a more aggressive rate hike profile (more in line with what the RBNZ has
projected), we believe that a re-think will occur over coming months for the following reasons:
continued NZD strength will moderate inflation pressure to a greater degree than assumed in today's RBNZ forecasts;
the rising NZD will also moderate the outlook for the recovery in export growth and add to the downward pressure on farm
incomes;
continued mixed global data are likely to confirm concerns about the pace of international growth;
the migration cycle is likely to move beyond its peak, pointing to a moderation in the pace of the housing market;
consumer sentiment is likely to soften further as a result of rising interest rates, which is expected to lead to weaker
retail sales activity; and
business confidence is turning down in response to a stronger currency and prospects of weaker consumer demand.
In conclusion, we expect that the RBNZ would have insufficient arguments for supporting a more aggressive tightening
profile than 25 bps steps in both July and August.
Full text of the RBNZ press statement
Official Cash Rate increased to 5.5 per cent
The Reserve Bank today increased the Official Cash Rate from 5.25 per cent to 5.5 per cent.
Reserve Bank Acting Governor Rod Carr commented "Demand conditions no longer warrant the degree of interest rate
stimulus that seemed necessary late last year. The economy's ability to meet increasing demand without pressure on
costs, margins and therefore prices appears limited. Core inflation is still at the upper end of the 0 to 3 per cent
target band, leaving little headroom for price pressures to accelerate from here on.
"Pressures on resources look likely to be maintained in the foreseeable future. New Zealand's population is expanding
rapidly with the sharp turnaround in net migration. Migration is contributing more to strong household spending,
residential construction and housing market activity than it is to the availability of labour. And a recovery in global
demand - although fragile in some respects - is now underway with Consensus Forecasts rather more optimistic than
earlier in the year.
"The influences on inflation are not all operating in the same direction. The exchange rate has been rising and
international prices for some key exports, such as dairy products, have fallen sharply. These factors, if sustained,
will reduce domestic activity to some degree and help to dampen inflation pressures in due course.
"On-balance, in the absence of some further withdrawal of monetary stimulus, these factors together would place
additional pressure on the economy's already-stretched resources, producing a rise in inflation pressures. Accordingly,
today's decision is a further step in the process of reducing the interest rate stimulus that we put in place last year,
when the outlook for the economy looked decidedly weaker.
"At this point, it appears likely that further increases in interest rates will be required over the year ahead,
possibly to a greater extent than we projected in March. However, as discussed further in this Statement, the outlook is
always subject to uncertainty. We will continue to monitor the range of influences on the inflation outlook and make the
necessary policy adjustments", Dr Carr concluded.
Ulf Schoefisch, Chief Economist, New Zealand