OCR: What the economists said

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The OCR was yesterday left at 2.5%. Here's what some of the country's economists thought of the decision.

Friday, January 31st 2014, 6:00AM

BNZ:

We have been critical of the Reserve Bank for delaying the removal its OCR super-stimulus, while economic momentum and inflation risk has accumulated so much. But at least yesterday, while leaving its cash rate at its extraordinarily low level of 2.5%, the Bank clearly beefed up its hawkish rhetoric. With this, it said it was “committed” to lifting the OCR, starting “soon”.   For this we can commend the Bank.

In the end, the Bank talked at far greater length about the economy than we anticipated. We thought it might be inclined to keep in short and sweet. Not so.  Then again, the Bank’s discussion gave us plenty of helpful reference points. And the more we read of it,  the more hawkish it came across.

Yes, there was a simple repeat of the structure of December’s positive speak. But this was added to in no small measure. For example, that “consumer and business confidence were strong” (note the order) and that the rise in net inward migration was now “rapid”. Firms’ pricing intentions got a mention this time, in that they “have been rising”. Construction costs…”risk feeding through to broader costs in the economy” whereas in December the Bank said it all still depends.

As for GDP growth, Wheeler said he expected this to persist around a 3.5% annual pace over the coming year. This, in the first instance, is an admission the RBNZ has increased its GDP track, given its December MPS had growth running at closer to 3.0% for calendar 2014. But we also note that even 3.5% looks light to us. We project something closer to 4.0%, and with business and consumer surveys warning of something above 5.0%.

If the “scale and speed of the rise in the OCR will depend on future economic indicators” we suggest it won’t be long before the RBNZ gets a hurry up from the data.  The next big lot, by the way, is next Wednesday’s labour market reports, in the form of the Q4 Household Labour Force Survey, Labour Cost Indexes and Quarterly Employment Survey.

Granted, not everything was stepped up in yesterday’s OCR review. The Bank mentioned, for example, that “there appears to have been some moderation in the housing market in recent months”. We suspect this alludes to slower turnover. However, it’s not clear that prices, which the Bank judges as clearly overvalued, are coming to heel. What is true is that it will take another few months of data, at least, to get a clear steer on housing trends, post October’s introduction of high-LVR lending restrictions.

There was also the mention about the “high exchange rate”. But this was nothing new. If anything, the Bank continues to betray a growing acceptance of the currency’s strength, as testimony to the economy’s relative momentum and attributes (much like Moody’s affirmed earlier this week). The last time Wheeler tried to have a real go at the NZ dollar was back in October and that pretty much backfired. That the “The Bank does  not believe the current level of the exchange rate is sustainable in the long run” does not sound like a lot of immediate concern to us.  

The Bank sounded a bit guarded about global growth.  To be sure, it stated that “export demand should benefit from improving growth in the global economy”. But this was conditioned by misgivings about the degree of monetary stimulus the global economy was reliant on, especially, de facto, in respect to emerging market economies, where recent ructions have been most noticeable. But surely one of the messages from this  is that one should be wary of becoming dependent of overly cheap money in the first instance.
As for conclusions, especially with regard to the monetary policy outlook, the Reserve Bank couldn’t have been clearer. Not only did it see the “need to return interest rates to more-normal levels” (bearing in mind the Bank is on record as suggesting a neutral nominal 90-day rate is probably around the 4.50% level, inferring a 4.25% OCR).

But that the Bank “expected to start this process soon”. Sure, The Bank didn’t go as far as to say it would be hiking at its 13 March Monetary Policy Statement. But then central banks are loath to give exact time references. “Soon” means March as far as we’re concerned.

And just because the Bank didn’t hike \ does not necessarily mean it wasn’t considered as a serious proposition. But perhaps the central bank felt it hadn’t given fair warning in early Statements of pulling the trigger this early (even though the economic information was cementing the case for it)? Some consistency was at stake. The recent ructions in emerging market might also have been a consideration, at the margin. Anyone reading yesterday’s OCR text, though, might well have wondered why the Bank did not make a start.

As for the market reaction, the immediate response was to adjust to the fact the Wheeler did not hike yesterday, rather than to his beefed up hawkish rhetoric. This exerted a downward pressure on local wholesale yields, more so at the short end, as the residual odds of a hike yesterday could be taken out of equations. In keeping with this, NZD/USD also dipped, around 75 pips, to around 0.8185 (although has since wriggled back up a bit).

These reactions, while understandable, should not be taken as a sign that the market isn’t taking the RBNZ rhetoric seriously. Indeed, when the dust settles we believe people will more and more realise that Graeme Wheeler delivered a fairly hawkish statement yesterday.  And we do mean fairly. The question is whether it’s  fair enough, by which we mean fully appreciative of  the upside risks to inflation and thus the OCR.  The answers will become very clear this year.

JP MORGAN:

RBNZ Governor Wheeler left the OCR on hold at 2.5%, in line with our forecast and consensus, but guided heavily toward a rate hike in March, as most expected him to.

Market pricing implied a decent chance of a rate hike (approx 30%), and it would have been hard to call tightening a mistake given the performance of the economy. The main reason we saw the Governor waiting for the next meeting is that word count would be a constraint, with the short OCR announcement (running less than a page) not giving sufficient space to articulate how the tightening cycle was expected to play out, and also to tie up loose ends, particularly regarding what happens to LVR restrictions once rates are rising.

There is much more space to do this in the meatier MPS document in March, which also comes with updated growth, inflation, rates and currency projections, and a press conference.

Conveying more urgency in the language than we have seen, Governor Wheeler notes that “there is a need to return interest rates to more-normal levels. The Bank expects to start this adjustment soon.” This is about as explicit as he can get about the next meeting, and it seems it will be hard to knock Governor Wheeler off the path toward tightening in March. That conviction is well-motivated, with the economy still described as having “considerable momentum”, with upgrades to the assessment around export prices (“very high” from “continued to increase” in December) and new notes on the very upbeat state of consumer and business confidence. Also there is mention for the first time of some pick-up in firms’ pricing intentions (“rising”) and of spillover from construction costs which “risk feeding through to broader costs in the economy.”

The RBNZ’s bill projections have suggested 200bp of tightening over the next two years, which would take them to their assessment of neutral. It is understandable then that they would want to get under way soon, but the surprise for the market in yesterday’s language is that beyond the very high  likelihood of a move in March, there is more equivocation around the remaining 175bps than some might have expected. The statement ends with “the scale and speed of the rise in the OCR will depend on future economic indicators”, which suggests significant conditionality, and there is mention for the first time of “some moderation in the housing market.”

Presumably this is a reference to the role of LVR restrictions, with data released this week having shown high LVR lending dropping to levels significantly below the thresholds required by the legislation. This is not made explicit though, and any mention of LVR restrictions has been mysteriously vanished out of the commentary, having been there in December.

The challenge for RBNZ watchers in this cycle has been in trying to read the Bank’s view on the interplay between the OCR and LVR restrictions. The latter were originally framed as complementary to monetary policy, but were then used as an interim substitute that would provide “flexibility” on the timing and magnitude of rate hikes. Initial estimates pegged the restrictions as being equivalent to 30bp in monetary policy space, but recent data, and yesterday’s language, now implies the spillover might be greater.

With the OCR likely to go up at the next meeting, there now is a need to articulate how the Bank will switch gears between the use of LVR restrictions and OCR hikes. LVR restrictions were always described as temporary, and to have a limited shelf life in a world where rates are rising. The measures only came in on October 1, so it seems inevitable there will be some overlap, since an ungracefully hasty unwind of the policy might damage perceptions of the Bank, or of the tools themselves. And assuming some overlap, it is unclear how long the two mechanisms will be working in tandem, and whether this assumption is embedded in the last rate projections. These loose ends need to be tied up, and we expect that to happen in the March MPS.
Or, Governor Wheeler’s speech today may provide more clarity.

For now though, on the evidence that LVR restrictions are biting a little harder than expected, and will be working in tandem with OCR increases for a time, it seems right to be a little cautious around assuming that the full extent of tightening implied by market pricing (+125bps over the next year) actually will be delivered (JPM forecast +75bp). And to us, that message also was conveyed by the conditional nature of Governor Wheeler’s guidance.

WESTPAC:

The RBNZ left the OCR on hold but sent the clearest possible signal that it intends to hike the OCR in March. The key comment was: “...inflationary pressures are expected to increase over the next two years. In this environment, there is a need to return interest rates to more-normal levels. The bank expects to start this adjustment soon.”

This was precisely what we and most other economists expected the RBNZ to do. It was also, in our opinion, the wisest course of action.

It is now abundantly clear that the economy warrants a higher OCR. As the RBNZ said, “New Zealand’s economic expansion has considerable momentum”, and inflation is rising.

But to deliver a hike without prior warning and without much accompanying explanation might have appeared panicky and high-handed. Markets might have pushed the exchange rate and interest rates higher than the RBNZ intends.

The better option for the central bank was to wait six weeks until March, when it can deliver an OCR hike backed by a Monetary Policy Statement and a full set of economic projections. A hike in March is also anticipated by financial markets, and will therefore cause less market volatility.

The RBNZ has been emphasising the importance of clear communication as an aid to effective policymaking. The decision is entirely consistent with that emphasis.

In the same vein, we will be watching closely the speech the Governor is due to give in Christchurch today. This will be a great opportunity for the Governor to add colour around what the RBNZ expects to do with the OCR this year, including outlining the risks and contingencies.

As anticipated, the body of yesterday’s press release gave the impression that the RBNZ is now considering a more aggressive hiking cycle than it signalled six weeks ago in the December MPS.

Extremely bullish words were chosen to describe the current state of and outlook for economic activity in New Zealand. The RBNZ is now forecasting around 3.5% GDP growth for 2014 compared to the forecast of 2.9% published in the December MPS.
Importantly, the RBNZ also sounds more concerned about inflation pressures. We took particular note of the comment: “Construction costs are increasing and risk feeding through to broader costs in the economy.” In the past, the RBNZ has sounded more sanguine about the risk of the construction boom feeding through to inflation.

But the press release wasn’t all bullish. The RBNZ acknowledged that there has been some moderation in the housing market. We agree with that assessment, and we would add that we anticipate further moderation ahead. However, the RBNZ factored a housing market slowdown into its thinking when it introduced the high-LVR mortgage restrictions. We suspect that the actual housing market slowdown has, so far, been no steeper than the RBNZ anticipated.

Similarly, the RBNZ described global growth as “improving”, but did note that the uncertain pace of US monetary tightening and the effect on emerging markets was a risk.

Comment on the high exchange rate was light, and focussed on the effect that the exchange rate is having on inflation: “The high exchange rate continues to dampen inflation in the traded goods sector, but the Bank does not believe the current level of the exchange rate is sustainable in the long run.” In other words, the exchange rate is suppressing inflation for now, but it probably won’t continue doing so for much longer, so OCR hikes will be needed instead. We concur with that assessment.
This OCR Review portrays a central bank that is calmly preparing for a steady but extensive series of OCR hikes.

Yes, it does seem that the total size of the hiking cycle will be slightly larger than previously signalled. But there were no signs of panic in this press release.

Financial markets went into the statement pricing roughly a 30% risk of a hike yesterday. With that risk removed, interest rates and the exchange rate had to fall. The two-year swap rate fell from 3.84% to 3.78%, and the NZD/USD exchange rate fell from 0.8263 pre-meeting to 0.8182 in the wake of the decision.

With such a steady hand on the monetary tiller, markets are now able to rule out some of the wilder RBNZ scenarios that had been floated. For example, it now strikes us as quite unlikely that the RBNZ will hike the OCR by more than 25 basis points in March.
Markets are now pricing 111 basis points worth of OCR hikes over 2014 – we roughly concur with that assessment.

HSBC:

The RBNZ left the cash rate unchanged at 2.50%. The central bank was noticeably more upbeat on the outlook for domestic activity. However, their concern over the high NZD seems to have held them back from hiking rates today. Instead, the RBNZ significantly bolstered their tightening bias, flagging that interest rate rises would be needed and noting that they expect 'to start this adjustment soon’. With demand booming and inflation already running ahead of the RBNZ’s expectations, we expect that they will need to hike rates soon in order to keep inflation contained. A hike seems likely in March.

Facts
- The RBNZ kept its overnight cash rate unchanged at 2.50% (12 of 15 analysts expected no change; HSBC had expected a 25 basis point hike).
- On economic activity, the central bank was more upbeat, noting ‘New Zealand’s economic expansion has considerable momentum’.
- On the NZD, the RBNZ continued to note that ‘the Bank does not believe the current level of the exchange rate is sustainable in the long run’.
- On the outlook for policy, the central bank flagged ‘a need to return interest rates to more-normal levels’ and that the RBNZ ‘expects to start this adjustment soon’.

Implications
Momentum is continuing to build in the New Zealand economy, and the RBNZ acknowledged this, presenting a noticeably more upbeat view on the economy. With demand booming and the economy already at capacity, cost pressures are beginning to rise and the central bank strengthened their tightening bias by flagging upside risks to the inflation outlook.
However, despite increased inflation risks, a stronger domestic outlook and recent upside surprises to the RBNZ’s own forecasts the central bank chose not to lift rates. In our view, a strong case could be made for tightening rates now. However, lingering concerns about the high NZD seem to have been a key factor behind the central bank’s decision to delay increasing rates – with the central bank continuing to note that, in their view, the current level of the exchange rate is not sustainable in the long-run.
Instead, the RBNZ flagged that rate increases are imminent, strengthening their language around the need for higher interest rates. The RBNZ noted that the current economic environment suggests ‘a need to return interest rates to more-normal levels’ and that they ‘expect to start this adjustment soon’. A hike seems likely in March.

Bottom line
The RBNZ left the official cash rate unchanged at 2.50%  and strengthened their language around the need for higher interest rates.
The central bank presented a more upbeat view on the outlook for the domestic economy, but lingering concerns about the high NZD seem to have driven a further delay in tightening.
With demand booming and the economy already operating at capacity, a hike in March seems likely in order to keep inflation contained.

ASB:

The RBNZ held the Official Cash Rate (OCR) at 2.5% at yesterday’s Review.  This was in line with the expectations of most forecasters, who, along with ourselves, expected March was the more likely meeting the RBNZ would chose to lift the OCR.  The RBNZ provided a clear signal that OCR increases are imminent: “In this environment, there is a need to return interest rates to more-normal levels. The Bank expects to start this adjustment soon.” We maintain our long-held view that the RBNZ will hike the OCR by 0.25% in March, and gradually lift the OCR to 4% by the end of 2015.

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