The RBNZ easing cycle begins

• The RBNZ surprised markets with a 25 basis point cut in the Official Cash Rate, on a more pessimistic view of export prices, and a more determined strategy to lower the NZ dollar.
• The NZ 2 year swap rate fell around 25 basis points to 3.10%, consistent with the market pricing an additional 50 basis points of cuts over the next 6 months.
• The NZ government 10 year bond yield finished the month broadly unchanged at 3.65%, with more accommodative local monetary policy offset by the drag of global yields rising around 25 basis points.
• The US Federal Reserve has kept the door open to start lifting the Fed Funds rate in September.
• Credit spreads widened marginally on the month, reflecting ongoing risks from political uncertainty in Greece and market instability in China.

The RBNZ’s June Monetary Policy Statement was always going to be an interesting OCR decision, with economists and the market roughly split 50:50 on whether they would cut interest rates by 25 basis points.  While softening economic data suggested that they “should” cut, it wasn’t clear that they “would” cut given the pre-conditions they set out in the April OCR Review.

As it turned out, the RBNZ tore up the previous script, not only cutting by 25 basis points, but opening the door to lower the OCR further.  The biggest change in the RBNZ’s economic view was around export prices, which dominated its discussion.  Not only had the RBNZ been surprised by the fall in dairy prices to date, but it was much more pessimistic about the prospect of dairy prices bouncing high enough to justify Fonterra’s current forecast for the dairy pay-out in 2015/16.  That represents a significant hit to New Zealand income, at the same time that import costs have risen following the rebound in petrol prices.

However, there was also a tactical element to the RBNZ interest rate decision and forecasts.  For a number of years now, the RBNZ (and market) has been surprised by inflation undershooting its forecasts.  The June MPS seemed to mark a change in mindset, with the RBNZ now deliberately trying to lift inflation quickly back to target, and appear comfortable risking an overshoot to the upside – anything to finally get away from the bottom of the target range. 

Subsequent to the MPS, the political pressure faced by the RBNZ Governor became apparent with some uncharacteristically pointed comments from Bill English published in a Bloomberg interview: “He’s been out of the zone for years now, below the midpoint for quite some time”, “He’s meant to be following the Policy Targets Agreement”, “one day somebody will start asking the Minister of Finance questions about whether he’s actually following the agreement or not”.