Flash Notes-RBNZ: More Rate Cuts Ahead
This morning, the Reserve Bank of New Zealand (RBNZ) cut the official cash rate by 25bp to 3.00%. The accompanying statement noted that the growth outlook is now softer than at the time of the Bank’s June Statement with rebuild activity in Canterbury appearing to have peaked and the world price for New Zealand’s dairy exports having fallen sharply. On the inflation front, the RBNZ said that annual CPI inflation is now expected to be close to the midpoint of the 2-3% target range in early 2016, due to recent exchange rate depreciation and as the decline in oil prices drops out of the annual figure, although a key uncertainty is how quickly the exchange rate pass-through will occur.
More importantly, the statement concluded with the observation “At this point, some further easing seems likely”. This clearly shows the RBNZ retaining an easing bias. Recall that after successive rate hikes in Q1 and Q2 last year in response to rampant inflation stemming from an overheated property market, the RBNZ entered a wait-and-see mode for the remainder of 2014 and most of 2015. This was until last month when the New Zealand central bank chose to cut the official cash rate by 25bps, citing falling commodity prices and a softer outlook for inflation and growth.
Seasonal adjusted GDP grew a measly 0.2% in Q1, completely missing an expected 0.6% expansion, as primary industries activity fell 2.9%; lower dairy production and softening activity in the mining sector were to blame. Also, business investment expenditure, a key component of economic development, came in very soft. A greater cause of concern is the inflation outlook. Last week’s CPI inflation data for the June quarter recording soft readings of 0.4% q/q, 0.3% y/y, much weaker than the RBNZ’s annual inflation target-range midpoint of 2%. And dairy prices fell for the ninth consecutive time at last week’s fortnightly Global Trade Auction (GDT), slumping an average 10.7%, with whole-milk powder prices alone tumbling 13.1%.
The odds of further monetary easing from the RBNZ have certainly increased. We now expect further two rate cuts before the end of the year, most likely at the next two meetings, taking the cash rate back to 2.50%. However, the phrase “At this point” implies that there could be some room to suspend policy easing in the event of positive developments. Over the coming weeks, the RBNZ will thus be keeping a close watch on dairy prices and the exchange rate. Besides, the one big factor holding the RBNZ from reducing the cash rate faster is an overheated property market in Auckland (which accounts for around one third of NZ’s total population). However, the RBNZ has previously noted that planned LVR measures should reduce pressure in the housing market, freeing up the bank to loosen monetary policy as it attempts to support economic activity in the broader economy.
On the New Zealand dollar, previous policy statements had described the currency as unsustainably and unjustifiably strong. But today, the RBNZ noted the significant recent depreciation, although it continues to see a further decline in the exchange rate as desirable. NZD/USD, as a result, rose sharply as markets took the signal that the RBNZ’s comfort level for the currency was a great deal closer than where it was just a few months ago. Following this morning’s RBNZ announcement, we are maintaining our NZD/USD forecasts.
