June 8, 2016

Financial stability reason for unchanged OCR

The Reserve Bank may have left the OCR unchanged – due to a more upbeat economic assessment – this morning, but economists continue to expect a further cut to come.

Prior to this morning’s monetary policy statement (MPS), commentator expectations had largely changed from a June cut to a preference for a cut in August instead.

For this reason, Governor Graeme Wheeler’s announcement today that the OCR would remain at the already record low of 2.25% took few economists by surprise.

Westpac chief economist Dominick Stephens said the Reserve Bank’s decision was very much in line with his expectations.

In the MPS, the Reserve Bank sounds more constructive on the economy and more confident that inflation is rising towards their 2% target, he said.

“That gives them time to hold the OCR at 2.25% a bit, but they maintained their easing bias language, saying ‘Further policy easing may be required’.

“The 90-day interest rate forecast was unchanged from March and settles at 2.1%, indicating one more OCR reduction.”

Stephens said Westpac saw nothing to dissuade them from their forecast of an August OCR cut, although this does depend on the data.

However, he added that Auckland house price inflation was still adding to the Reserve Bank’s financial stability concerns.

“The Reserve Bank also sounded more concerned about the high exchange rate holding down inflation.”

For BNZ senior economist Doug Steel, there were two key issues in the Reserve Bank’s announcement this morning.

BNZ had expected the Reserve Bank to hold the OCR this morning, but Steel said it was clear the Reserve Bank is weighing up a wide range of issues, particularly the high NZ dollar and the housing market.

“The persistently strong currency – which got a bit higher on the back of this policy announcement – is annoying them. It is an argument for lower rates to offset the deflationary impact of the higher dollar.

“The other major influence is the housing market. There was a lot more concern from the Reserve Bank on the financial stability risks that it poses.”

In his view, any future move on the part of the Reserve Bank is highly dependent on the relevant data in these areas.

However, in our recent OCR preview survey, Steel said the economic and inflation outlook was likely to lead to another 25 bias point cut in August.

ASB senior economist Jane Turner was slightly surprised by the Reserve Bank’s move this morning, as they were expecting a cut to the OCR.

She said financial stability concerns appear to have influenced the decision not to cut rates and the Reserve Bank might be stalling to allow time to introduce further macro-prudential tools.

“The Reserve Bank assumes the NZ dollar will fall to reach their inflation target – but the TWI has lifted in reaction to today’s statement.

“If we haven’t seen the currency decline by August, the Reserve Bank will have to cut the OCR to reach their inflation targets.”

While today’s MPS was very similar to the March statement, on the margins, it is slightly more upbeat in its tone on dairy and the global outlook, Turner said.

“They are still wary of the large downside risks in those areas. But they did seem to be a bit less concerned. That stood out to us.”

Overall, ASB continues to expect the Reserve Bank to cut the OCR to 2% in August, she said.

“We continue to see downside risks to the RBNZ’s inflation outlook.  As a result, we continue to expect the cash rate to eventually fall to 1.75%, although the Reserve Bank appears very reluctant to cut rates.”

Financial markets reacted to the announcement by sending the exchange rate one cent higher, and 2-year swap rates 3 basis points higher.