The Reserve Bank of New Zealand (RBNZ) has cut the official cash rate (OCR) by 25 basis points, bringing the leading interest rate down to 2.25%. The bank will consider additional easing to anchor inflation expectations.
IHS perspective | |
Significance | The rate-cut by the RBNZ brings the OCR down to a new record-low of 2.25%. The announced rate-change came largely as a surprise to markets, with the New Zealand dollar falling sharply in response to the doveish tone of the announcement. |
Implications | RBNZ governor Graeme Wheeler additionally promised further interest-rate cuts, with the aim of anchoring inflation expectations while bolstering the economy against risks such as subdued global growth and domestic agricultural production. |
Outlook | IHS had expected the OCR cut, and we currently expect at least one more cut to occur in 2016 as inflation will remain constrained by low oil prices and weak global demand. We adjusted our forecast in February after Wheeler shifted to a significantly more doveish tone in the late-January policy statement. The RBNZ retains room for manoeuvre to counter deflation and support growth without resorting to the quantitative-easing measures seen in other advanced economies. |
Return of deflation risks causes RBNZ to reconsider monetary policy position
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Following the 25-basis-point cut to the OCR in December 2015, Wheeler's statements and the bank's forecast for the 90-day bank bill rate (a proxy OCR forecast) had indicated that the RBNZ was concluding its latest round of monetary easing, and would be switching to a neutral bias for monetary policy: in other words, the OCR would remain at the record low of 2.50% for some time. This was based on the expectation that annual average inflation for 2016 would average just over 1%; therefore when oil prices weakened further, and the headline consumer-price index (CPI) figure for the December quarter of 2015 came in at 0.1% year on year (y/y) – the weakest result since 1999 – the RBNZ's January monetary policy statement indicated that further monetary easing may be necessary (see New Zealand: 29 January 2016: Reserve Bank of New Zealand leaves interest rates on hold as economy once again flirts with deflation).
In his post-decision statements following the rate-cut to 2.25%, Wheeler stressed that the bank expects inflation to rise over the course of 2016, but added that it will now take longer to reach the bank's official target range of 1–3%. In fact, the bank's revised inflation forecast, which was simultaneously released in the RBNZ's Quarterly Monetary Policy Statement, shows inflation reaching only the lower bounds of the inflation target by the last quarter of 2016 – a significant downward revision from its previous forecasts. This raises the risk that inflation expectations of households and businesses will edge further downwards, with such sentiments becoming self-fulfilling and resulting in a prolonged period of very low inflation – if not deflation; however, the RBNZ has room for manoeuvre to head off this risk.
In addition to the inflation risk, there are significant downside risks to the economic-growth outlook. Wheeler indicated that external downside risks to the growth outlook for New Zealand emanate from the poor global growth outlook, led by uncertainties over China as well as volatility in global financial markets. Downside domestic growth risks are focused largely on weakness in the dairy sector (due to demand and supply issues), in addition to the negative impact of weak inflation expectations. Conversely, the RBNZ expects the economy will continue to receive support from the current loose monetary policy settings; a pipeline of construction activity from earthquake-reconstruction activity in Canterbury and new housing starts in and around major cities; net inward migration adding to the pool of consumers; and continued robust tourism activity. A further potential upside is that the bank's surprise rate-cut and explicit easing bias will exert sustained downward pressure upon the New Zealand dollar. Wheeler drew attention to the fact that the currency's trade-weighted exchange rate was over 4% stronger than the projection of December 2015, and the governor indicated that any significant decline would be appropriate, considering the ongoing weakness in the country's key commodity prices.
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Wheeler concluded that further monetary policy easing "may" be necessary to return inflation to the bank's informal target of 2%, or the middle of the inflation target range. The governor's statement is supported by the bank's revised forecast for the 90-day bank bill rate, which appears to indicate a total of 50 basis points' worth of easing during 2016, with a second 25-basis-point rate cut occurring between June and September. There could be further adjustments in 2017, but much will depend on how the inflation and growth outlooks evolve over the coming months. By comparison, the forecast during December 2015 was for the bank bill rate – and, by proxy, the OCR – to remain steady throughout 2016 and 2017.
Outlook and implications
In line with the RBNZ's proxy OCR forecast, IHS expects the bank to lower the OCR by a further 25 basis points in August; this will be the RBNZ's first meeting after the second-quarter inflation figures are released. We expect inflation to remain weak in the first half of 2016 – in large part due to low oil prices and net inward migration suppressing wage growth – thus encouraging the second rate cut. In the latter half of 2016 – between unfavourable base effects, a slow upward drift in oil prices, and the accumulated effects of currency weakness – IHS expects inflation to return above the lower band of the RBNZ's inflation target range; this will encourage the bank to at least leave rates on hold at the new low levels. However, there is a significant risk of further rate cuts, depending on how inflation expectations and other economic data unfold. Under Wheeler's leadership the RBNZ has been a significantly proactive central bank, taking decisive and rapid action where necessary. This has led to some policy reversals – but if interest rates had not risen in 2014, the bank would have been left with less room for manoeuvre during the current economic conditions.