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The RBNZ Left The OCR Unchanged At 3.0% As Expected

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Fuseworks Media
The RBNZ Left The OCR Unchanged At 3.0% As Expected

The RBNZ delivered a very dovish statement, with the projection for the 90-day track slashed by 140 basis points. The 90-day rate gradually increases to just 4.7% by the end of 2013, in contrast to June Monetary Policy Statement where the 90-day rate peaked at 6.1%. The RBNZ was very explicit that the statement implied several on-hold decisions. The RBNZ is very comfortable with the inflation outlook and is in no hurry to lift interest rates in the here and now.

Behind the stark change in view are substantially weaker growth forecasts and more emphasis placed on higher bank funding costs and the expectation that this dynamic is likely to persist for much longer than previously expected. Importantly, the RBNZ has undertaken a major rethink on the household sector outlook, with forecasts for household spending and residential investment scaled back substantially (note the forecasts were finalised before the earthquake, and have not been revised to incorporate the impact on GDP and inflation). The RBNZ highlighted the continued caution evident in consumer spending, weak housing market and very weak appetite for credit.

While the household outlook has been revised down, the RBNZ's export outlook remains largely unchanged. While the outlook for the global economy has deteriorated somewhat, the RBNZ noted the strength in growth from Australia and China which will continue to provide support to export prices.

The RBNZ noted that the Canterbury Earthquake reconstruction efforts will require "considerable resources over the next year or two, particularly in the construction sector". However, the RBNZ was quick to highlight that the Policy Targets Agreement requires the RBNZ to look through any temporary price spikes that are generated as a result. In the media conference following, Governor Bollard noted that while the RBNZ expected higher inflation in the Canterbury region, it would be concerned if the higher inflation spilled over to other regions as a result of resources will be diverted to the Canterbury region. The RBNZ continues to expect medium-term inflation expectations will remain anchored, but outlines in a Box a scenario what would happen if this was not the case.

Implications This MPS has brought a huge shift in the RBNZ's view of the recovery - even before the impact of the earthquake starts getting taken into account. Particularly, it has reinforced that the OCR is unlikely to climb substantially during the tightening cycle. Two key reassessments have brought this on: the extent of recovery in household demand, and; (in effect) the neutral level of the OCR. On both fronts the RBNZ has surprised with the extent to which it has cut back its outlook - even ourselves, who have had the lowest forecast for the eventual OCR peak.

Our view of a 4.5% OCR peak is effectively where the RBNZ's 90-day outlook implies the OCR will eventually end up - and we don't think this pre-earthquake view from the RBNZ will have changed. We have been pointing out since the start of the year that that changed funding costs have meant that the neutral cash rate is (for the next couple of years at least) substantially lower than it used to be, and that the eventual peak will be very low. We continue to see this low peak as entirely reasonable.

However, we do expect inflation will be a little stronger than the RBNZ currently assesses, and that the path to a 4.5% OCR will be a little faster than the 2 and a half year time frame the RBNZ's forecasts currently imply. Nevertheless, it remains likely that the RBNZ will be on hold for the rest of the year, at least while the economic impact of the earthquake remains uncertain. The urgency to act has gone. There is the risk that when the tightening cycle recommences that it will be a stop-start path. Market pricing already has a fairly gradual pace priced in, though implied pricing for the eventual OCR peak will still look low compared to the RBNZ's outlook. Right now the RBNZ is certainly not encouraging any closing of that gap at the moment, but longer term the market's implied OCR peak will likely prove to be too low. Market reaction Swap rates dropped on the announcement, with short-term rates dropping around 9 basis points. The curve has steepened, due to smaller drops for longer-term rates. The NZD has also dipped. Prior to the announcement, the NZD was trading around USD 0.73, and in the subsequent minutes dipped to around 0.726. The NZD has also dropped noticeably against the AUD. Prior to the meeting the cross rate was around 0.78, and in the wake of the announcement has dropped to 0.774.

In the short-term, it is likely that the NZD remains weak, as New Zealand interest rate markets adjust lower. But we wouldn't get too bearish on the NZD, given the environment of low volatility and the relative yield pick-up still offered by New Zealand term-rates. There is certainly more downside in the NZD/AUD on a medium-term basis (to below 0.77) because of the clear guidance the RBNZ has delivered on the interest rate outlook, compared to the upside risks to the Reserve Bank of Australia (RBA) interest rate outlook. Full statement below

RBNZ news release - OCR unchanged at 3.0 percent

The Reserve Bank today left the Official Cash Rate (OCR) unchanged at 3.0 percent.

Reserve Bank Governor Alan Bollard said: "While the global and domestic economies continue to recover, the outlook has weakened since our June Statement. We consider it appropriate at this point to keep the OCR on hold.

"The earthquake that struck Canterbury on 4 September has significantly disrupted economic activity and is likely to continue to do so for some time yet. Many homes and businesses have been damaged, as have significant parts of Canterbury's public infrastructure. Eventual reconstruction and repairs will require considerable resources over the next year or two, particularly in the construction sector. If, in the aftermath of the earthquake, the prices of some goods and services increase temporarily, monetary policy would remain focused on the medium-term trend in inflation. The Policy Targets Agreement explicitly instructs the Bank to look through temporary price increases generated by a natural disaster.

"Looking more generally at the domestic economy, the household sector remains cautious, with consumer spending soft, house sales falling and house prices remaining flat. With continued soft demand for credit, this suggests household spending will not increase to the extent previously projected.

"The pace of expansion in the global economy appears to have slowed in recent months with forward indicators of US growth, in particular, deteriorating noticeably. Nevertheless, continued strong growth in Australia and China will support demand for New Zealand exports, reinforcing the continued contribution of high export commodity prices.

"Overall, despite the weakened outlook, we still expect that growth will progressively absorb current surplus capacity over the next few years. In addition, changes to indirect taxes and earthquake impacts will cause headline inflation to spike higher over the coming year. Previous experience of GST increases, the fact that annual CPI inflation has been near 2 percent for the past year and a half, and the subdued state of domestic demand suggest this inflation spike will have little impact on medium-term inflation expectations.

"Over time, it is likely that further removal of monetary policy support will be required. The pace and extent of further OCR increases is likely to be more moderate than was projected in the June Statement."

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