The RBNZ delivered on a widely-expected cut, slashing the OCR by 25 bps from 2.00% to a record low of 1.75%, which caused the Kiwi to rise.
Wait, what? Yep, you read that right.
However, all became right again when the Kiwi tanked across the board during the presser with RBNZ Guv’nah Wheeler.
What’s up with that? Well, read on and find out!
Why the RBNZ cut rates
Wheeler clarified during the presser that the RBNZ slashed rates because of the following reasons:
- The RBNZ “has signaled the cut” in the past as part of its forward guidance
- The cut “is needed to get the growth … needed to reduce the output gap“
- To “deliver inflation back into the target range“
- To “reduce the risk of short-term expectations falling“
The first reason is self-explanatory and is mainly linked to the RBNZ’s credibility. The second, third, and fourth reasons, meanwhile, are actually linked. You see, the RBNZ actually doesn’t have a problem with New Zealand’s GDP growth. In fact, the November Monetary Policy Statement even shows that the RBNZ slightly upgraded its GDP projections for the December quarter from a 0.9% rate of expansion to a slightly faster 1.0% pace, as you can see below (click the image to enlarge).
The RBNZ and New Zealand do have a problem with low inflation, however. And by cutting rates to fuel further growth, the RBNZ hopes to reduce the output gap, which is the difference between the maximum potential output and actual output in a given economy. And by reducing the output gap, the RBNZ hopes to increase domestic inflation, particularly non-tradables inflation, which is inflation from goods and services for immediate domestic consumption and/or are not affected by international competition (e.g. utilities, rent, insurance).
Let me clarify a bit. New Zealand’s CPI is split roughly 50-50 between non-tradables and tradables inflation. And New Zealand’s persistent inflation problem comes mainly from tradables inflation, which has been negative for five years already, according to Wheeler.
Unfortunately, the strong Kiwi and weak global inflation have made imports rather cheap, but the RBNZ has very limited influence on that. The RBNZ is therefore focusing on what it has more influence on, which is non-tradables inflation.
Anyhow, the RBNZ expects that its rate cut, as well as other easing moves in the past, would allow inflation to rise by the December 2016 quarter to 1.1% year-on-year, which is within the lower bound of the RBNZ’s annual 1-3% target inflation range.
RBNZ does not like the Kiwi’s strength
As usual, Wheeler complained about the Kiwi’s recent strength, saying that:
“The exchange rate remains higher than is sustainable for balanced economic growth and, together with low global inflation, continues to generate negative inflation in the tradables sector. A decline in the exchange rate is needed.”
For reference, the RBNZ forecasted that the Kiwi’s trade-weighted index (TWI) would slide lower to around 74.5 in the August Monetary Policy Statement, but it stood at 79.23 while Wheeler was complaining.
And also, as usual, Wheeler cited “Weak global conditions and low-interest rates relative to New Zealand” as being the reasons for the Kiwi’s strength, implying that demand for the Kiwi is being driven by the search for high yet relatively safe yield in a low-yield world.
The RBNZ has been wrong time and time again, but it still expects the Kiwi’s TWI to continue to dip lower, “reflecting an improvement in global economic conditions and a narrowing of interest rate differentials between New Zealand and other advanced economies.” The TWI is now expected to fall to 76.8 by December 2016, which is higher than the 74.4 projected during the August Monetary Policy Statement.
RBNZ less likely to cut?
In the September statement, Wheeler said that:
“Our current projections and assumptions indicate that further policy easing will be required to ensure that future inflation settles near the middle of the target range.”
But for the November statement, Wheeler had a softer yet more ambiguous tone, saying that:
“Our current projections and assumptions indicate that policy settings, including today’s easing, will see growth strong enough to have inflation settle near the middle of the target range. Numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly.”
During the presser a journalist asked Wheeler to clarify the RBNZ’s current monetary policy bias by asking the following question:
“Do you think that this is as low as interest rates go from a business and consumer point of view in New Zealand?”
Wheeler answered by pointing out that the RBNZ’s projection for the OCR is to fall at 1.70% by June 2017 and stay there. This implies, according to Wheeler, that “there’s a 20% probability of a further cut.” However, Wheeler added that further cuts are dependent on how New Zealand’s economic indicators evolve.
RBNZ has “an open mind” on intervention
Late into the RBNZ presser, Wheeler was asked if the RBNZ has considered intervening in the forex market, given the Kiwi’s recent strength. And Wheeler answered the following:
“We [the RBNZ] always have an open mind. We look at the case for intervening at the time that we take our decisions around an OCR. We’ve got a system of four traffic lights. And we look to see whether the conditions have been met at any point. So we have an open mind about intervention.”
A journalist pressed Wheeler further and asked if the RBNZ’s traffic light system is now signaling an “all green.” Wheeler just curtly replied that “I’d rather not, uh, cover that at this stage.”
Hmm. Very interesting. In the June RBNZ presser, Wheeler was also asked about the possibility of intervening, but he didn’t want to talk about it. Wheeler even voluntarily added that the RBNZ only has a limited ability to intervene.
The possibility of an RBNZ intervention was brought up again during the August RBNZ presser. And while Wheeler refrained from giving a straight answer back then, he did address the question, saying that “let me not comment further at this point about whether we’re intervening or not.”
But now, Wheeler openly admitted that the RBNZ has been discussing the possibility of intervention during its meeting. Is that desperation setting in? Maybe the RBNZ is getting desperate enough to intervene soon? In any case, a very interesting development indeed.
On Trump’s victory and the Fed
The very first thing Wheeler was asked about during the presser was actually on the RBNZ’s view on Trump’s victory and whether it changed the RBNZ’s outlook in any way.
Wheeler shared that the RBNZ already made the decision to cut before Trump’s victory became clear. He added, however, that RBNZ officials did meet after Trump’s victory to discuss if they needed to amend or rethink their decision, but they “came to the conclusion that they didn’t need to do either.”
A journalist with apparently anti-Trump sentiments later asked Wheeler the following loaded question during the presser:
“What do you think would dominate the Fed’s thinking? The recessionary effects of Trump’s trade policy or the fiscal irresponsibility of his tax policy?”
Wheeler sheepishly answered (while chuckling) that: “The Fed has terrific expertise … they’ll look at certain indicators like non-farm payrolls and they’ll go about their business as one would expect that they would.” In short, Wheeler thinks that the Fed’s decision would be data-dependent.
The rate cut was widely expected and the RBNZ had a rather softer yet more ambiguous tone towards the future path of monetary policy, which is probably why the Kiwi initially rallied when the decision was announced.
However, the presser with RBNZ Guv’nah Wheeler revealed that the RBNZ still has a slight easing bias.
Moreover, Wheeler blatantly stated that the RBNZ discussed the possibility of intervention and even had “an open mind” to intervening, which is a noticeable change in how he handled questions with regard to intervention in the past, which is probably why the Kiwi tanked during the presser.