RBNZ Observer Update: Another hike delivered, with more to come

The RBNZ increased its cash rate by +25bp to 3.00% today, as expected. The economy is picking up strongly and the RBNZ has continued on a path to return rates to more normal levels, to keep inflation contained. The central bank kept the prospect of further rate hikes at coming meetings open, however, the statement expressed increased concern over the high NZD. Overall, with demand continuing to rise strongly, we expect the central bank to hike rates further in 2014, with a 25bp increase at the June meeting likely. However, a strengthening exchange rate may mean slightly fewer hikes than the market is currently pricing.

Facts
- The RBNZ increased its cash rate by 25bp to 3.00%, as expected by all 15 surveyed analysts (including HSBC).

- On the outlook for policy, the RBNZ noted ‘the speed and extent to which the OCR will be raised will depend on economic data and our continuing assessment of emerging inflationary pressures, including the extent to which the high exchange rate leads to lower inflationary pressure’.

- On the economy, the RBNZ stated ‘New Zealand’s economic expansion has considerable momentum’.

- On the NZD, the RBNZ noted that ‘the Bank does not believe the current level of the exchange rate is sustainable’.

Implications
The RBNZ continued on a path of returning interest rates to more normal levels, by raising its cash rate by 25 basis points to 3.00%. The New Zealand economy continues to pick up strongly, supported by post-earthquake reconstruction, rising house prices, increased consumer spending and strong migrant inflows. With demand rising and the economy already at capacity, the RBNZ needs to move gradually away from current loose monetary settings to keep inflation in check.

Today’s statement from the central bank suggested that this process is likely to continue at upcoming meetings. The central bank noted ‘the speed and extent to which the OCR will be raised will depend on economic data and our continuing assessment of emerging inflationary pressures, including the extent to which the high exchange rate leads to lower inflationary pressure’. With the economy on track to post one of the strongest growth rates in the OECD this year, we expect the central bank to follow up with a further 25bp hike at the June meeting.

However, a couple of factors may hold back the extent of further rate hikes in 2014 (the market is currently pricing another 60bps before year-end). First, the RBNZ remain concerned about the high NZD, explicitly noting its strength in today's policy statement. The NZD TWI is now +2.5% above their March projections. Second, the pace of decline in dairy prices is also likely to have surprised the central bank. In March, RBNZ projections implied a 3.75% cash rate by year-end. We expect the stronger NZD and drop in export prices to limit the increase to 3.50%.

Bottom line
The RBNZ increased its cash rate to 3.00%, as expected.

With demand continuing to pick-up strongly in New Zealand, we expect further hikes in 2014 with a 25bp increase at the June meeting likely.

However, the elevated exchange rate and the recent fall in export prices may mean slightly fewer hikes this year than the market is currently pricing.

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