The Reserve Bank of New Zealand (RBNZ) lowered the official cash rate (OCR) by 25 basis points to 2.00%, with the bank's governor indicating that further easing is likely.
Implications | The RBNZ has kept rates on hold since enacting a similar 25-basis-point rate cut in March. After deciding to deal with continued house-price appreciation through macroprudential policy, the bank will be free to lower the OCR in the future if inflation remains low. |
Outlook | IHS Markit expected the OCR cut to occur during this meeting. Based on the statements from the RBNZ governor Graeme Wheeler, it appears likely that the bank will continue the easing cycle with a further cut during the next three-to-six months. The key driver for a cut would be lower-than-expected September-quarter inflation, which would result in an OCR cut at the bank's November meeting. |
Underperforming inflation main driver in RBNZ decision to resume easing
The Reserve Bank of New Zealand (RBNZ) had been indicating the possibility of lowering the official cash rate (OCR) to 2.00% since its March meeting, when the bank released its forecast of the 90-day bank bill rate (a proxy OCR forecast), but chose to keep rates on hold at subsequent meetings until the release of the June quarter inflation figures in late July (see New Zealand: 19 June 2016: Low June-quarter inflation means further monetary easing likely by the Reserve Bank of New Zealand). With headline consumer price index (CPI) growth at 0.4% year on year (y/y) for both the March and June quarters – well under the bank's official target range of 1-3% – the RBNZ decided that further delay to easing would risk permanently dampening inflation expectations . Given the persistent weakness in inflation, the RBNZ further lowered its 90-day bank bill rate forecast- as part of its August monetary policy statement release. The bank's updated forecast calls for up to 50 basis points' worth of cuts between until June quarter of 2017. RBNZ governor Graeme Wheeler directly indicated following the decision that, based on the bank's forecasts, further policy easing will be necessary.
Wheeler, in his post-decision statements following the OCR cut to 2.00%, stressed that persistently negative tradables inflation was the main culprit behind the lower headline CPI figures. The higher interest rates in New Zealand relative to other developed economies have bolstered the New Zealand dollar exchange rate, reducing the price of imports and causing tradable-goods prices to fall. The continued low price of oil is also a significant contributor to the persistence of this deflationary trend in tradables. Wheeler expects further weakness in inflation during the September quarter as these issues persist, taking the view that while long-term inflation expectations are currently well-anchored at the bank's informal inflation target of 2%, continued weakness in headline inflation has the potential to lower inflation expectations.
Despite low inflation, domestic growth has remained relatively resilient. The economy continues to be supported by strong inward migration, accommodative monetary policy, continued reconstruction activity following the Canterbury earthquakes, and increased tourism. However, agricultural producers, including the country's crucial dairy sector, are being negatively affected by low prices, and are still recovering from lower production due to drought conditions from the El Niño weather pattern. Any deterioration in economic growth in the June quarter – released in September – would likely force a more substantial easing response from the RBNZ.
Housing prices remain on RBNZ's agenda
House price inflation once again featured in the monetary policy assessment as one of the main risks to financial stability. In particular, Wheeler pointed to the fact that rising house prices have become more broad-based, and have spread to regions outside of Auckland. The RBNZ previously stated through a July speech by its deputy governor Grant Spencer, and a special bulletin on financial stability in housing market cycles, that it would make use of macroprudential actions to ease price pressures in the housing market. The bank is acting quickly, having released a consultation paper in mid-July on new regulations that are to go into effect by 1 September. Subject to the consultations, the new restrictions would once again focus on limiting growth in high loan-to-value (LTV)-ratio mortgages. By implementing additional macroprudential regulations, monetary policy is given room to focus on targeting inflation.
Outlook and implications
Based on the statements from Wheeler and the revisions to the 90-day bank bill forecast, IHS Markit now expects that the RBNZ will lower the OCR by at least 25 basis points during the next year, with the most likely timing at the bank's November meeting. Based on recent movements in the oil and currency markets, it appears increasingly likely that inflation will remain weak, if not soften further in the current quarter. However, in subsequent quarters IHS Markit expects inflation to rise on the back of a weakening exchange rate and a recovery in oil prices; this will lead to an eventual reversal of the RBNZ's cutting cycle. However, if June- or September-quarter GDP growth comes in significantly weaker than expected, it is possible that the bank will decide to lower the OCR by at least a further 25 basis points period between the present and the end of 2016. We currently expect interest rates to remain unchanged until late 2017, but this timeline could become extended based on inflation and economic growth.