RBNZ cuts OCR, further cut ‘likely’; inflation to rebound

RBNZ cuts OCR to 2.75%, further cut ‘likely’, but tradables inflation bounding back

By Jonathan Underhill

Sept. 10 (BusinessDesk) - The Reserve Bank cut the official cash rate as expected and said further easing seems likely but also telegraphed a rebound in tradables inflation because of the weak kiwi dollar and a pickup in crude oil prices.

Governor Graeme Wheeler cut the official cash rate a quarter point to 2.75 percent, saying a reduction in the OCR was warranted because of the “softening” New Zealand economy.

He cut the near-term track for economic growth, slashed the projected path of the trade-weighted index and forecast the 90-day bank bill rate will settle 50 basis points lower than was seen in the June statement. But having lowered the estimates for annual inflation this year, the Reserve Bank sees the rate rising above the mid-point of its target range by September 2016.

“Headline inflation is expected to return well within the target range by early 2016, as the earlier petrol price decline drops out of the annual inflation calculation, and as the exchange rate depreciation passes through into higher tradables prices,” Wheeler said in a statement released in Wellington.

“At this stage, some further easing in the OCR seems likely”, dependent on the emerging flow of economic data, he said.

The New Zealand economy is growing at an annual pace of about 2 percent – down from a previous estimate of 2.5 percent, Wheeler said. The domestic economy was adjusting to a sharp decline in export prices and consequent fall in the exchange rate, while building work in Canterbury was plateauing and both business and consumer confidence had weakened, he said.

The biggest adjustment to the bank’s projections is for the exchange rate. It sees the TWI averaging 67.9 in the fourth quarter, down from its June forecast of 73.6, and sinking to an average 64.8 in the June quarter 2017.

Wheeler softened his language on the currency, saying today that “further depreciation is appropriate, given the sharpness of the decline in New Zealand’s export commodity prices.”

Yet one of the bank’s key assumptions is that commodity prices have “troughed” and are now on the way to a gradual recovery. That’s been reflected in the past two GlobalDairyTrade auctions, which have seen a rebound in prices from a six-year low after Fonterra Cooperative Group cut the volumes of milk powder offered for sale.

The bank also assumes the exchange rate remains low, boosting both tradables inflation and the tradables sector. Tradables inflation turns from -2 percent in the June quarter this year to 2.4 percent in the same period of 2016, adding 1.9 percentage points to annual inflation.

That’s partly the mechanical effect of the decline in the price of petrol in early 2015, estimated to have shaved 1.3 percentage points from tradables inflation in the first quarter, dropping out of the annual inflation rate from the start of 2016.

It also reflects a weaker TWI, which raises the New Zealand dollar price of imports and is estimated to add about 3.5 percentage points to tradables inflation over the coming year.

“Considerable uncertainty exists around the timing and magnitude of the exchange rate pass-through,” Wheeler said.

A softer domestic economy means annual non-tradables inflation is forecast to fall below 1.5 percent in late 2015 and pick up gradually to about 2 percent in 2018.

The Reserve Bank’s key assumptions include that net migration has peaked, have exceeded its expectations to reach record levels this year, reducing pressure on supply and demand. Yet the influx will continue to support growth, as will the large pipeline of construction activity in Auckland and elsewhere, and low interest rates.

House prices in Auckland “continue to increase rapidly and are becoming more unsustainable,” Wheeler said. It “will take some time” before a rise in residential construction in the country’s biggest city is able to correct the imbalance, he said.

World growth is assumed to remain near its average level, although the outlook has been revised down because of weaker growth in developing economies, especially in China and east Asia.

The monetary policy statement makes little mention of fiscal impetus, but it does project slower return to budget surplus than Finance Minister Bill English has predicted.

The Reserve Bank sees the government operating balance, as a percentage of GDP, remaining negative until 2017, when it is forecast at -0.4 percent. In June it forecast the operating balance at 0.5 percent of GDP.

A Reserve Bank official said the difference with fiscal projections mainly reflected the bank’s economic assumptions, which include a weaker track for the terms of trade relative to budget 2015.

(BusinessDesk)

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