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As expected, the RBNZ kept the OCR unchanged at a record low 1.75%, but the Kiwi plunged super hard as a result. What’s up with that? What did Wheeler and company say or do that caused the Kiwi to tank that hard? Well, here are the key highlights from the RBNZ’s May statement and presser that you should know about.

NZD/USD: 15-Minute Forex Chart
NZD/USD: 15-Minute Forex Chart

Neutral bias maintained

As mentioned earlier, the RBNZ decided to keep the OCR steady at 1.75%. However, the RBNZ also just shrugged off the mostly positive economic reports, including the sharp increase in headline Q1 inflation, and decided to maintain its neutral monetary policy bias.

To quote RBNZ Guv’nah Wheeler himself:

“Developments since the February Monetary Policy Statement on balance are considered to be neutral for the stance of monetary policy.”

The RBNZ’s May Monetary Policy Statement also explained why the RBNZ thinks maintaining a neutral policy bias is the correct decision.

“Premature tightening of policy could undermine growth, causing inflation to persistently undershoot the target midpoint. Further policy easing, in an attempt to see non-tradables inflation strengthen more quickly, would risk generating unnecessary volatility in the economy.”

A journalist also directly asked Wheeler about the RBNZ’s policy bias during the presser:

“You don’t sound like like you’ve even moved an inch towards a tightening bias that many expected, so you’re basically saying that you’re still very much neutral on monetary policy?”

And Wheeler answered as follows (emphasis mine):

“Yeah, we’re neutral on monetary policy and, you know, for the foreseeable future we would expect the OCR to remain at its current level.”

That bit about the OCR remaining at current levels “for the foreseeable future” actually leads to the next key highlight.

Path to hiking unchanged

The RBNZ not only maintained its neutral monetary policy bias, it even maintained its projections for the OCR, so the RBNZ still expects no rate hikes until the later half of 2019 at the earliest.

RBNZ OCR Projections (Click to enlarge)
RBNZ OCR Projections (Click to enlarge)

Q1 CPI downplayed

New Zealand’s headline Q1 CPI jumped by 1% quarter-on-quarter, which is the fastest quarterly increase since Q2 2011. Year-on-year, this translates to a 2.2% surge, the strongest annual reading since Q3 2011.

Instead of being happy about this, the RBNZ merely downplayed this surge by pointing out that the sharp increase “was mainly due to higher tradables inflation, particularly petrol and food prices” and then saying that “These effects are temporary and may lead to some variability in headline inflation over the year ahead.”

Wheeler also said the following during his presser:

“We are not seeing the buildup in inflation pressure that some other commentators are seeing.”

Moreover, the RBNZ upgraded its annual CPI forecasts for the rest of 2017, but downgraded its forecasts for Q1 2018, but upgraded the forecasts for the rest of 2018. Forecasts for 2019, meanwhile, were unchanged.

RBNZ CPI Projections (Click to enlarge)
RBNZ CPI Projections (Click to enlarge)

The changes are as follows:

  • 2017 June – 2.1 (1.5 previous)
  • 2017 September – 2.1 (1.5 previous)
  • 2017 December – 1.7 (1.3 previous)
  • 2018 March – 1.1 (1.3 previous)
  • 2018 June – 1.4 (unchanged)
  • 2018 September – 1.7 (1.5 previous)
  • 2018 December – 1.8 (1.7 previous)
  • 2019 March – 1.9 (unchanged)
  • 2019 June – 2.0 (unchanged)
  • 2019 September – 2.0 (unchanged)
  • 2019 December – 2.1 (unchanged)
  • 2020 March – 2.1 (unchanged)
  • 2020 June – 2.0 (new)

The upgraded forecasts for 2017 reflect the strong inflation in Q1, thanks to tradables inflation. But as mentioned earlier, the RBNZ believes that the boost from tradables inflation would only be temporary, which is why the forecasts for 2018 were downgraded while the projections for 2019 were unchanged.

Growth downgraded

The RBNZ also downgraded its quarterly GDP projections for Q2 2017, although growth is expected to recover, so growth projections for the rest of 2017 until Q1 2019 were upgraded.

RBNZ GDP Projections (Click to enlarge)
RBNZ GDP Projections (Click to enlarge)

The changes are as follows:

  • 2017 March – 0.9 (unchanged)
  • 2017 June – 0.9 (1.1 previous)
  • 2017 September – 1.0 (0.9 previous)
  • 2017 December – 0.9 (0.7 previous)
  • 2018 March – 0.9 (0.7 previous)
  • 2018 June – 0.8 (0.7 previous)
  • 2018 September – 0.8 (0.6 previous)
  • 2018 December – 0.7 (0.6 previous)
  • 2019 March – 0.7 (0.6 previous)
  • 2019 June – 0.5 (unchanged)
  • 2019 September – 0.5 (unchanged)
  • 2019 December – 0.5 (unchanged)
  • 2020 March – 0.5 (unchanged)
  • 2020 June – 0.5 (new)

The downgraded growth forecasts for Q2 2017 were due to:

  • slightly weaker forecasts for consumer spending
  • lower gross fixed capital formation
  • temporary weakness in 2017 exports

Consumer spending

The downgraded forecasts for consumer spending was due to “nominal wage growth [remaining] subdued, in part reflecting the effects of low past inflation.”

Another factor is that “Migration is also contributing significantly to the supply of labour in the economy, which is offsetting the inflationary pressure associated with the increase in demand.”

And all the more so because “The recent compositional shift away from student visas towards work visas, if sustained, is likely to create some additional demand pressure.”

In simpler terms, weak inflation in the past kept wages down. Also, more workers are now migrating to New Zealand, which would likely depress wages further.

Gross fixed capital formation

Moving on, the RBNZ downgraded its projections for gross fixed capital formation mainly because “banks’ appetite for lending for residential property development appears to have reduced.” As a result, some construction companies have reported “some increased difficulty in obtaining finance.”

Exports

Export growth for all of 2017 was downgraded from 3.5% to just 1.4%. This reflects lower commodity prices and key downside risks, which “include the possibility of a global shift to more inward-looking and protectionist trade policies, and a more pronounced slowdown in China.”

RBNZ expects Kiwi to fall further

RBNZ TWI Projections (Click to enlarge)
RBNZ TWI Projections (Click to enlarge)

The RBNZ forecasts that the Kiwi will fall further. In fact it downgraded (upgraded?) its forecasts for the Kiwi’s trade-weighted index (TWI) as follows:

  • 2017 June – 76.0 (78.9 previous)
  • 2017 September – 75.8 (78.6 previous)
  • 2017 December – 75.5 (78.3 previous)
  • 2018 March – 75.3 (77.8 previous)
  • 2018 June – 75.2 (77.2 previous)
  • 2018 September – 75.0 (76.7 previous)
  • 2018 December – 74.8 (76.3 previous)
  • 2019 March – 74.6 (76.1 previous)
  • 2019 June – 74.4 (75.9 previous)
  • 2019 September – 74.3 (75.8 previous)
  • 2019 December – 74.1 (75.6 previous)
  • 2020 March – 74.0 (75.4 previous)
  • 2020 June – 73.9 (new)

The revisions reflect lower demand for the Kiwi due to narrower interest rate differentials. Geopolitical risks are also a factor, and ” Currencies that are perceived as being sensitive to global trade and commodity prices have led the recent falls.”

Hints of a potential easing bias?

When the RBNZ discussed its outlook for the Kiwi’s TWI, it gave this rather interesting warning (emphasis mine):

If world interest rates remain low for longer than currently anticipated, or if recent changes in market sentiment reverse, the TWI could be higher than currently projected. If a higher exchange rate were to reflect weak conditions abroad, it could necessitate more-stimulatory monetary policy to offset the impact on inflationary pressure. However, if a higher TWI were the result of stronger economic conditions in New Zealand, this could be accompanied by increasing domestic capacity pressures, and a monetary policy response might not be necessary.

With regard to the constraints on construction activity imposed by tighter lending standards, the RBNZ also had this to say if construction activity contracts worse-than-expected to fails to recover (emphasis mine):

“The lower level of construction activity would have two effects: it would reduce growth in the supply of housing, and it would lead to capacity pressure developing more slowly than in the central projection. While lower housing supply would increase house price inflation, the net response in the real economy would be a lower level of inflationary pressure as a result of less capacity pressure”

“To offset weaker inflationary pressure in the scenario, the OCR would need to fall, reaching 1.3 percent by the end of 2018 and remaining below the central projection over the forecast horizon.”

Final Thoughts

Overall, the RBNZ’s monetary policy stance was still very neutral, which very likely disappointed market players who were expecting the RBNZ to be a bit more hawkish, given the recent economic developments in New Zealand.

In addition, the RBNZ downplayed the recent surge in inflation and even forecasted that inflation will ease back down before rising again. Furthermore, the RBNZ also downgraded its growth projections for 2017 and 2018.

And finally, the RBNZ’s projection for the path of the OCR did not budge a bit. And these things, taken together, crushed the dreams of interest rate junkies and made them cry, sending the Kiwi plunging as a result.

There also hints that RBNZ may potentially switch to an easing bias, depending on how scenarios identified by the RBNZ play out, which may have also helped kick the Kiwi lower, although only speed readers would have probably picked up on those hints.