As expected, the RBNZ announced that it decided to keep the OCR steady at 1.75% yesterday. However, the Kiwi jumped higher as a result.
1. Upbeat economic outlook
2017 and 2018 CPI forecasts upgraded
The RBNZ upgraded its CPI forcast for Q4 2017 and all of 2018, so much so that the RBNZ now expects to hits its 2% target for annual inflation by the June 2018 quarter (Q2 2018 in other words).
This is much earlier compared to the forecast from August where CPI isn’t expected to hit 2.0% until March 2019.
And according to the RBNZ, the upgraded inflation forecasts reflect an expected gradual increase in non-tradables inflation “as capacity pressures increase,” as well as higher tradables inflation “due to the lower New Zealand dollar and higher oil prices.”
However, the RBNZ also pointed out that the inflationary pressure from tradables inflation “is expected to soften in line with projected low global inflation,” which is why the forecasts for 2019 were unchanged while the forecasts for 2020 were very slightly downgraded, but still within the RBNZ’s 2.0% target.
Here is the list of changes to the RBNZ’s annual CPI forecasts:
- 2017 December – upgraded to 1.8% (1.3% previous)
- 2018 March – upgraded to 1.5% (0.7% previous)
- 2018 June – upgraded to 2.1% (1.3% previous)
- 2018 September – upgraded to 2.2% (1.6% previous)
- 2018 December – upgraded to 2.1% (1.9% previous)
- 2019 March – 2.0% (unchanged)
- 2019 June – 1.9% (unchanged)
- 2019 September – 2.0% (unchanged)
- 2019 December – 2.0% (unchanged)
- 2020 March – 2.0% (unchanged)
- 2020 June – downgraded to 2.0% (2.1% previous)
- 2020 September – downgraded to 1.9% (2.0% previous)
- 2020 December – 2.0% (new)
GDP growth forecasts downgraded, but…
The RBNZ remained optimistic on growth and even upgraded its growth forecasts for Q4 2019 and 2020. However, the RBNZ expects the New Zealand economy to slow down first. And to that end, the RBNZ downgraded its growth forecasts for the rest of 2017, 2018, and Q1 2019.
And the RBNZ explained that the revisions reflect how the RBNZ thinks key policies of the new government will affect the New Zealand economy.
And these new policies are:
- government spending initiatives
- the government’s housing programme
- changes to requirements for work and study visas
- and increases to the minimum wage
The RBNZ concluded that the net effect of those policies would be more fiscal stimulus. And that would be positive down the road, which is why it upgraded its GDP growth forecasts for Q4 2019 and 2020.
However, the RBNZ also conceded that there are a lot of uncertainties surrounding those policies, which is why nearer-term GDP growth forecasts were downgraded.
The expected visa changes, in particular, are expected to result in weaker consumer spending, “because the impetus from population growth wanes.” Although the government’s plan to increase minimum wages would help to partially offset this.
By the way, here is the full list of the changes to the RBNZ’s growth forecasts:
- 2017 September – downgraded to 0.7% (0.9% previous)
- 2017 December – downgraded to 0.9% (1.0% previous)
- 2018 March – upgraded to 1.2% (1.0% previous)
- 2018 June – downgraded to 0.8% (0.9% previous)
- 2018 September – downgraded to 0.8% (0.9% previous)
- 2018 December – downgraded to 0.7% (0.8% previous)
- 2019 March – downgraded to 0.7% (0.8% previous)
- 2019 June – 0.7% (unchanged)
- 2019 September – 0.7% (unchanged)
- 2019 December – upgraded to 0.7% (0.6% previous)
- 2020 March – upgraded to 0.7% (0.5% previous)
- 2020 June – upgraded to 0.7% (0.5% previous)
- 2020 September – upgraded to 0.6% (0.5% previous)
- 2020 December – 0.5% (new)
2. Faster path to hiking
The RBNZ decided to retain its neutral policy bias for the nearer term while leaning more towards a hiking bias down the road when it noted that:
“In the current environment, additional stimulus would risk generating unnecessary volatility in the economy, while a premature tightening would risk undermining growth and could cause headline inflation to settle below the midpoint of the target range.”
More importantly (for rate hike junkies), the RBNZ also decided to upgrade the path for the OCR to show that the RBNZ may be ready for a rate hike by the June 2019 quarter or Q2 2019 (September 2019 quarter previously), due to the fact that the RBNZ expects to hit its CPI target much earlier.
And since the RBNZ also expects that the new government’s policies will result in stronger GDP growth down the road, the RBNZ also signaled that it may be ready for another rate hike by September 2020.
Incidentally, acting RBNZ Governor Grant Spencer was asked during the presser why the RBNZ only upgraded the path of the OCR by one quarter, given that the RBNZ expects to hit its CPI target much sooner.
And Spencer answered by referring back to its inflation forecasts, which is that the Kiwi’s recent weakness and higher commodity prices have resulted in stronger-than-expected tradables inflation growth. However, tradables inflation growth is expected to soften to more sustainable levels in the future, which is why the path for the OCR was only upgraded by one quarter.
3. RBNZ happy with the Kiwi
The RBNZ noted in its press statement that:
“The exchange rate has eased since the August Statement and, if sustained, will increase tradables inflation and promote more balanced growth.”
Acting RBNZ Governor Spencer was asked during the presser to “put a bit of context” on the RBNZ’s stance on the Kiwi’s exchange rate.
And Spencer answered as follows (emphasis mine):
“The currency is now closer to sustainable levels than it was previously. So, you know, we’re happy with this level of the currency. We think it’s in the vicinity of sustainable exchange rate.”
Speaking of the Kiwi, the RBNZ expects the Kiwi’s trade weighted index (TWI) to average around 73.5 throughout the forecast period. It jumped higher to 73.93 because of the RBNZ statement, though.
Anyhow, the RBNZ explained that the recent fall in the Kiwi’s TWI and forecast that Kiwi’s TWI will remain low “predominantly reflects reduced
appetite from offshore investors for New Zealand dollar assets rather
than a deterioration in the domestic economic outlook.”
And the RBNZ expects that foreign demand will remain low because of higher global inflation and expectations that the major central banks will tighten monetary policy in order to keep inflation growth at sustainable levels. And higher interest rates elsewhere will put interest rate differentials into play in favor of the other economies since the RBNZ is not expected to hike until 2019.
4. RBNZ not worried about dual mandate
As expected, acting RBNZ Governor Spencer was asked what he thinks about the new government’s plan to add “full employment” to the RBNZ’s mandate.
And, Spencer answered by first saying that his colleagues have similar views before saying the following (emphasis mine):
“Moving to a dual mandate is unlikely to have a major impact on the way we run monetary policy. Currently our approach, [which] we call flexible inflation targeting, so inflation is our primary target. But it is not our sole objective and we do look closely at the real economy and a whole range of economic variables.”
“Now with a dual mandate, it may be that our approach becomes more flexible. More flexible in the sense of allowing greater volatility in inflation in order to promote more stability in employment.”
“But in the current situation, I would say that the labor market is pretty balanced. And therefore I don’t think that the dual mandate, if we had it right now, would make much difference at all to our current monetary policy stance.”
The RBNZ signaled a faster path to hiking, which is surprising enough, given the new government’s plan to include full employment to the RBNZ’s mandate.
What’s more surprising, however, is that the RBNZ assessed that the new government’s policies would be net positive, which caused the RBNZ to forecast a second rate hike by Q3 2020. Also, acting RBNZ Governor Spencer expressed that he and his fellow policy makers aren’t too worried about having a dual mandate.
Given all that, it’s no wonder why the Kiwi’s reaction to the RBNZ statement was bullish.
However, future rate hikes are couched on the assumption that the Kiwi’s TWI will maintain its current levels of around 73.5 throughout the forecast period, since a weaker Kiwi would mean that imports become relatively more expensive, which would mean stronger tradables inflation. At the same time, a weaker Kiwi means that New Zealand’s exports become more competitive, which helps to sustain growth.
And monetary policy’s implied dependence on the Kiwi very likely made market players stop and think since there was little follow-through buying on the Kiwi and the Kiwi proceeded to trade sideways.