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RBNZ’s Wheeler keeps OCR on hold, no rate hikes ahead

12 Mar 2015

The Reserve Bank has removed the prospect of future interest rate hikes from its forecast horizon as a strong kiwi dollar and cheap oil hold down inflation, and the central bank ponders whether to lower its assessment of where "neutral" interest rates should be. The kiwi dollar gained after the statement.

Governor Graeme Wheeler kept the official cash rate at 3.5 percent, as expected, saying inflation is expected to stay low this year before gradually returning to the 2 percent midpoint of the central bank's 1 percent-to-3 percent target band, and an "extended" period of stability was needed.

"The fall in oil prices is a net positive for global economic growth, but will further reduce inflation in the near term, at a time when global inflation is already very low," Wheeler said when releasing today's quarterly monetary policy statement. "Future interest rate adjustments, either up or down, will depend on the emerging flow of economic data."

Wheeler has left the OCR unchanged since July to let him assess the impact of four earlier increases. Since then, various central banks around the world have been cutting their benchmark rates as plunging global oil prices took the wind out of any inflationary pressures, and traders have started pricing in a two-thirds chance of a 25 basis points cut by New Zealand's Reserve Bank before the end of this year.

That's seen the Reserve Bank trim 70 basis points from the track for the 90-day bank bill rate, often seen as a proxy for the OCR. The bank expects the 90-day rate to remain at 3.7 percent over its forecast period through to March 2017, a shorter timeframe than its last projection. It had previously forecast the rate rising to 3.9 percent in September, and 4.5 percent by the end of 2017. The kiwi jumped as high as 72.47 US cents after the statement from 71.84 cents immediately before and was recently at 71.94 cents.

"We expect the RBNZ to keep the OCR on hold, with the guidance likely to be similar to January's (which was repeated in Governor Wheeler's speech in February)," Westpac Banking Corp market strategist Imre Speizer said in a note before the release. "We see potential for a market surprise from the magnitude of change in the 90-day interest rate forecast, a downgrade highly likely."

The Reserve Bank slashed its expectations for annual inflation, which it sees staying below 1 percent until March next year, before rising to 1.7 percent by early 2017. That was due largely to the slump in oil prices last year, which reduces input costs for local businesses, and the central bank said a more "significant reduction" in consumer prices it would "warrant more supportive monetary policy."

Wheeler said the bank is "closely monitoring" the impact of weak inflation expectations on wage and price setting behaviour, particularly in the non-tradeable sector.

"The bank lowered its neutral nominal 90 day interest rate assumption following the global financial crisis. However, it remains an open question whether these changes were sufficient to reflect developments in recent years, including the more recent signs that longer term inflation expectations have adjusted lower."

Prime Minister John Key this week said he expected inflation to fall further and that there was "potentially a scenario where it's not an option for the bank to raise interest rates," though he wouldn't be drawn on whether Wheeler should cut rates.

While inflation has dropped below the bank's target band at an annual pace of 0.8 percent in 2014, the central bank has had contend with a resumption of rising house prices in Auckland, where supply hasn't managed to match demand.

The Reserve Bank last week announced plans to introduce a new asset class for residential investor loans, requiring higher capital ratios as a pre-cursor to potentially target macro-prudential tools.

The bank said the property market has tightened across the country since the middle of last year, though that was most pronounced in Auckland, where house price inflation is running at about 13 percent. The bank expects house prices to rise 8 percent in the year ending Sept. 30. Quotable Value figures this month showed property values rose at an annual pace of 6.4 percent in February, the fastest pace in five months.

The Reserve Bank is more bullish on the domestic economy as a result of cheap oil, predicting gross domestic product growth of between 3 percent and 4 percent over the next two years, having previously estimated annual expansion of about 3 percent in its December monetary policy statement.

Wheeler said the fall in oil prices "has increased households' purchasing power and lowered the cost of doing business," while employment and building activity remain strong, inbound migration is high and the housing market is picking up.

The currency is still a concern for the Reserve Bank, which Wheeler again said was "unjustifiably high and unsustainable" and that "a substantial downward correction in the real exchange rate was needed to put New Zealand's external accounts on a ore sustainable footing." The kiwi dollar has been on the decline in recent months as global investors heighten their expectations for higher US interest rates this year as the world's biggest economy continues to recover from the global financial crisis and subsequent recession.

The Reserve Bank expects the trade-weighted index to be at an average 77 in the March quarter of this year, edging down to 76.9 by the end of 2015. It had previously anticipated the TWI would be at 74.8 by the end of 2015.

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