Acting RBNZ Governor Grant Spencer isn't ruling out the possibility of an OCR cut, given the downside surprise of December's CPI data – he says the 'risks are two sided'

Acting Reserve Bank Governor Grant Spencer has used his last Monetary Policy Statement (MPS) press conference to signal the next move in interest rates could be up or down.

Speaking to reporters and analysts in Wellington this morning, Spencer said although the central bank is expecting the next move in the Official Cash Rate (OCR) to be up, there are also “risks to the downside.”

The Reserve Bank left the OCR unchanged at 1.75%. The wording in Thursday morning’s OCR press release said “…[monetary] policy may need to adjust accordingly” and made no mention of specific up or down moves.

When this was pointed out to Spencer, he said it was a “valid observation.”

“We have seen [inflation] surprise to the downside and if that continued, then it is possible that we can see interest rate reductions.”

The most recent consumer price index (CPI) inflation numbers, released in December, came in below market and economists’ forecast; rising just 0.1% for the quarter and 1.6% year-on-year.

The Reserve Bank was forecasting 0.3% and 1.9% rise respectively.

Spencer made note of the downside surprise in the MPS document, saying it was “lower than expected,” noting “the weakness was driven by softer tradables inflation.”

But, the central bank expects CPI inflation to trend upwards towards the 2% midpoint of the target range, and longer-term inflation expectations are “well anchored at 2%.”

Despite the downside inflation surprise, Spencer is not expecting the next OCR move to be down.

“If things pan out as we are forecast and expect, then we do see the next move to be upwards. That is reflected in our OCR track.”

“But,” he continues, “the risks are two-sided.”

Spencer was pressed about the Reserve Bank not meeting its inflation target. Its Policy Targets Agreement with the government mandates the central bank keeps inflation between 1-3% with a target of 2%.

Apart from briefly in 2017, CPI inflation has remained below the 2% level since late 2010.

But Spencer says the Reserve Bank has been within the 1-3% range for “a lot of time.”  

“That’s what flexible inflation targeting is about – we’re not trying to hit 2% on a continual basis,” he said.

“We don’t want to fine tune interest rates, moving them up or down to try and keep inflation at 2% – it’s not a sensible approach to policy. The sensible approach is to be patient and be confident; as long as we’re confident that things are moving back towards the target, that’s the approach we’re taking.”

Spencer elaborated on this when grilled by MPs at the finance and expenditure select committee later in the day, when asked by committee chairman, Labour’s Michael Wood, why the OCR had not fallen further, given “we have pretty soft inflation.”

The Acting Governor was adamant inflation would return, given the “growth and capacity” story in the New Zealand economy.

He adds that it would not be a good look if interest rates had to be eased, then subsequently had to go back up again.

Spencer also points out that further reducing the OCR would create more risk in the housing market.

“Any reduction of rates would risk reigniting housing and cause debt ratios to increase again.”

A warning to potential homeowners

Spencer also has some words of advice for would-be homeowners and current borrowers: be prepared for a shift in the global economy.

“[Interest rate] normalisation will happen – it has to happen,” he said.

Globally, interest rates and inflation have been at record-low levels. But as the global economy improves, Spencer says both interest rates and inflation will pick up.

“The risk is, and what we’re nervous about, is if that happens quickly,” he says.

Evidently, this is a concern shared by the financial markets. Earlier this week, US stock markets plunged after better than expected jobs data from the US was released.

The concerns for many was the jobs numbers suggested a stronger economy, which brings more inflation – something which has been lacking in the US for years.

This, in turn, could force the US Federal Reserve to hike interest rates, making borrowing more expensive.

A quick correction in the global market would hit the New Zealand housing market, Spencer says.

“The risk is bond rates sell off and increase in the international market. That follows through to New Zealand, that affects the bank’s cost of funds – so the mortgage rates, particularly on fixed mortgages, would increase.

“This is why borrowers and banks have to be careful about making sure that the debt service capacity is there – at not just today’s rates, but when rates are a bit higher.”

Should Kiwis be preparing for that?

“They should be, yes,” Spencer says.

“If you’re borrowing, then you should be thinking about if you can afford that mortgage at a 2% interest rate higher than you’re paying upfront.”

Official cash rates

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