RBNZ has opened the door to rate cuts (plural)

Mayday, Mayday, the RBNZ has opened the door to rate cuts (plural)

Key Points

• The RBNZ kept the cash rate unchanged at 1.75% today. The OCR decision is merely a placeholder between MPS dates, the next in May.

• The language shifted decisively towards rate cuts. The February MPS spoke of symmetric risks. Today’s OCR talks of asymmetric, DOWNside risks.

• RBNZ rate cuts are now much more likely than not.

• In an immediate change of call, we place a rate cut in May (with a 60% chance). One cut wouldn’t touch the sides, so we expect another follow up move to 1.25% in either August or November.

Summary

The Kiwi dollar has strengthened, albeit assisted by a strong terms of trade, and international developments have soured. The Kiwi flyer has outperformed the Aussie battler, impacting our manufactured exports. The RBNZ’s actions today went some way to lower the Kiwi dollar. But Adrian knows better than most, that words only last so long. The RBNZ has clearly changed tact today, focussing on the negative, and downgrading the positive. They’ve set us up for a rate cut. And may be in May.

Today’s opening line in the short statement said it all: “Given the weaker global economic outlook and reduced momentum in domestic spending, the more likely direction of our next OCR move is down.” Compared to “We expect to keep the OCR at this level through 2019 and 2020. The direction of our next OCR move could be up or down.” – written just last month.

The weakness seen out of our trading partners is key. So too is strengthening in our currency. With the deteriorating global backdrop, the RBNZ has become increasing worried. And the currency is one pressure relief valve the RBNZ can nudge, from time to time. Orchestrating easier financial conditions will need more than words. We’ve taken the short statement at face value, and immediately changed our view.

We had expected the RBNZ to keep the OCR unchanged deep into 2021. We’re all-too aware of the Governor’s bias to err on the side of caution. And Adrian has proven himself to be a man of action. Playing the man, not just the economic ball, we now expect a rate cut in the May MPS meeting, under the freshly formed committee. We now expect a 25bp rate cut in May, followed by another cut in August – largely depending on the performance of the currency.

In terms of ammunition, we have (at least) 125bps to play with. The RB could cut to 50bps in a heartbeat. Theoretically, the RB could then cut another 100bps to -50bps (negative rates) in a terrible crisis. But the bang from buck when cutting to 50bps and below, diminishes quickly. That’s when Quantitative Easing comes into play. QE is in every central bank’s playbook these days. So, arguments against rate cuts based on a lack of ammunition are worth listening to, in terms of diminishing impact, but not entirely accurate. The RBNZ has loads of ammunition and a stonkingly big printing press. When the economy is on fire, you just keep throwing water. And we’re nowhere near that.

The issue with cutting interest rates from here is a double-edged sword. Savers lose. Borrowers gain. We fear the rate cuts will enable banks to widen spreads in pre-loading for the new bank capital requirements.

Market Reaction

The market reaction was savage. The Kiwi interest rates market is heavily received, with rates dropping sharply across an illiquid curve. Indicative pricing is wide, but the May meeting as 10bps of a 25bp cut priced – so a 40% chance of a cut priced. We believe the risk is a little higher at 60%. August has 22bps priced – so 90% chance of a 25bp cut priced. And there’s a real risk the RBNZ could deliver two cuts by then. Payers in the rates market have been burnt, and will take some time to return

The 2-year swap rate, the rate bank’s use to hedge 2-year mortgage rates, nose-dived 13bps, with the 5-year close behind.

In terms of getting rates lower, Adrian has done a great job.

The NZD nosedived a cent to $0.6820 immediately following the Bank’s Statement.

Today’s one-pager is likely to have generated the desired reaction in financial markets. The RB will be happy.

RBNZ Statement

The Official Cash Rate (OCR) remains at 1.75 percent. Given the weaker global economic outlook and reduced momentum in domestic spending, the more likely direction of our next OCR move is down.

Employment is near its maximum sustainable level. However, core consumer price inflation remains below our 2 percent target mid-point, necessitating continued supportive monetary policy.

The global economic outlook has continued to weaken, in particular amongst some of our key trading partners including Australia, Europe, and China. This weaker outlook has prompted central banks to ease their expected monetary policy stances, placing upward pressure on the New Zealand dollar.

Domestic growth slowed in 2018, with softness in the housing market and weak business investment contributing.

We expect ongoing low interest rates, and increased government spending and investment, to support economic growth over 2019. Low interest rates, and continued employment growth, should support household spending and business investment. Government spending on infrastructure, housing, and transfer payments also supports domestic demand.

As capacity pressures build, consumer price inflation is expected to rise to around the mid-point of our target range at 2 percent.

The balance of risks to this outlook has shifted to the downside. The risk of a more pronounced global downturn has increased and low business sentiment continues to weigh on domestic spending. On the upside, inflation could rise faster if firms pass on cost increases to prices to a greater extent.

We will keep the OCR at an expansionary level for a considerable period to contribute to maximising sustainable employment, and maintaining low and stable inflation.

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