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RBNZ OCR Review: Wouldn't It Be Nice

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Fuseworks Media
Fuseworks Media
RBNZ OCR Review: Wouldn't It Be Nice

The RBNZ struck a surprisingly dovish chord in today's OCR review, reiterating that the OCR could still move lower in coming quarters and that it would remain at or below current levels until the latter part of 2010. The tone of the statement was if anything more downbeat than in June: there was no acknowledgement of the improving global outlook, rising net migration, the pickup in housing activity, rising business and consumer confidence, or the ongoing easing in effective interest rates as borrowers reset at lower rates.

The recent strength in the New Zealand dollar came in for some special attention. The RBNZ stated that the economic recovery they are forecasting is contingent on a weaker currency: "If this easing does not occur, the forecast recovery could be put at risk. In these circumstances we would reassess policy settings." That is, if the currency doesn't fall from here, they may cut rates further to offset the impact.

This dovish tone is at odds with the speech that RBNZ Governor Bollard delivered two weeks ago. Compared to the June Monetary Policy Statement, the speech conveyed a more confident tone that the recovery is under way - a patchy and gradual one, but a recovery nonetheless, and one that was likely to be stronger than for many developed economies. In that instance, the RBNZ appeared to view the higher dollar as something that could skew the mix of the recovery towards consumption over exports, rather than derailing it altogether as today's statement suggests.

So is the RBNZ serious about easing further, or is this just an attempt to talk the currency down in order to get a more desirable mix of financial conditions? It's certainly difficult to square a willingness to cut rates further with the RBNZ's long-running and recently revived concerns about the imbalances in New Zealand's economic growth. As Dr Bollard noted in his recent speech: "A clear risk beyond near-term recovery is that households resume their 'borrow and spend' habits... triggered, for example, by renewed moderate house price inflation. This needs to be avoided."

While a return to a debt-fuelled consumption binge isn't an immediate danger, the most likely catalyst would be if interest rates were kept too low once the recovery got under way. So further rate cuts in the short term may just mean that the RBNZ will have to work harder to cool domestic demand in the future - and markets are sufficiently forward-looking that they would factor this in through higher long-term interest rates, and possibly a higher exchange rate.

Another issue is whether the stronger currency actually does threaten the recovery. It's often the case that currencies are actually telling us something about the fundamentals, and it's not obvious that they've been wrong to date. Markets were quick to incorporate the view - now widely held - that a repeat of the Great Depression had been avoided, and more recently they have correctly anticipated the stabilisation and recovery in some segments of the global economy. As we've said before, if the market is overestimating the strength of the recovery, then the NZD is likely to fall of its own accord; and if the market is correctly anticipating the recovery then a stronger NZD won't be enough to cancel it out.

Nor is it obvious that the NZD is particularly stretched at current levels. The currency is around its long-run average on the trade-weighted index; it's slightly above average against the structurally weak US dollar and below average against the Australian dollar. While prices for New Zealand's 'soft' commodity exports haven't matched the recent rebound in 'hard' commodities, they are still around their long-term trend in NZD terms - an impressive performance, considering that they have generally fallen below trend during previous, milder global slowdowns (Figure 1).

So while the threat of further rate cuts can't be dismissed completely, we think the RBNZ will ultimately be guided by the outlook for domestic demand, the area over which it has the most influence. And if domestic conditions continue to improve at their recent pace, the RBNZ should be able to resist the temptation to deliver another short-term hit of monetary stimulus. As Dr Bollard's speech noted: "Sustainable recovery, with rebalancing in demand and the economy's productive base, is mostly a microeconomic matter." A greater contribution to growth from the export sector would be nice to have, but it's not essential for monetary policy.

Market implications The market responded to the more downbeat than expected tone to the statement, with two-year swap rates down by 14 basis points and NZD/USD dropping by 60pts to 0.6510 on the release. We expect these impacts to be temporary.

We remain of the view that the RBNZ won't cut rates further in this cycle, and that rate hikes will commence in the third quarter of 2010. However, the recent mixed signals from the RBNZ make it harder to predict how long they will persist with their easing bias.

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