Markets price in 40% chance of OCR cut

Interest rate derivatives markets are pricing in a 40% probability the Reserve Bank will cut the Official Cash Rate this year, amid weakening inflation and slower growth overseas.

Tuesday, January 15th 2019, 2:05PM

Overnight Indexed Swap (OIS) pricing reflects the increasing probability the Reserve Bank could cut rates this year, despite the central bank's projection rates will go up next time they change.

In his latest note, Kiwibank economist Jeremy Couchman noted wholesale interest rates have trended down since November, with the 2 year swap rate hitting a record low of 1.92%. Couchman said "markets look sensitive to downside surprises" at present.

It comes as the US Federal Reserve indicated it would take a patient, rather than aggressive approach, to interest rate hikes this year. Meanwhile, concerns about the Chinese economy grew last week as inflation figures fell below targets. The developments have led markets in New Zealand to price in a downward OCR move.

Kiwibank still believes the central bank will keep the OCR at 1.75% this year, with gradual hikes to follow in 2020. Couchman told TMM Online: "We are more positive on growth this year than the RBNZ. But clearly risks to our view are to the downside not the upside at present."

Couchman believes Adrian Orr's conservative stance, falling inflation, and new capital adequacy requirements have influenced the OIS market. He added: "At the beginning of 2019, local market participants seem very sensitive to any negative economic data. In particular we have seen some disappointing data out of China, including weak manufacturing and inflation data."

As the RBNZ waits for New Zealand to reach its GDP and inflation targets, some economists have begun to forecast an OCR cut. ANZ predicts a 25 basis point cut later this year, followed by a further 50 basis points in 2020. ANZ said concerns around global growth and liquidity, as well as weak inflation, could influence the central bank.

Westpac, meanwhile, has pushed back its OCR hike predictions, in light of recent developments. Westpac economist Dominick Stephens says the RBNZ's capital adequacy proposals are likely to force banks to raise interest rates, keeping the OCR lower for longer. Stephens believes there will be "a slightly slower pace of OCR hikes in the early 2020s" as a result.

Tags: ANZ Kiwibank OCR OCR forecasts