ASB economists think the Reserve Bank's likely to be unhappy with the market's current view that expects interest rate rises this year

By David Hargreaves

The Reserve Bank may need to sound “very dovish” in its outlook this week in order to quell market expectations of rising interest rates this year, ASB economists believe.

The RBNZ makes its latest call on official interest rates this Thursday. And while there’s virtually universal expectation that our central bank will leave the Official Cash Rate unchanged at 1.75%, money markets are already pricing in potential rate rises later in the year. This is despite the fact that most big bank economists see rates being unchanged all this year.

The expectations of upward interest rate moves have been heightened by recent Consumers Price Index figures, which showed inflation running a little higher than expected, and back into the RBNZ’s targeted 1%-3% range for the first time in over two years.

ASB senior economist Jane Turner said in the ASB’s Business Weekly Economic Report that the RBNZ faces a challenge on Thursday.

“…The market does not agree with economists on the OCR outlook, with market interest rates implying a rate hike as soon as the end of the year, and a 3% OCR by mid-2019,” she said.

“That is a long way from the RBNZ’s November [Monetary Policy Statement] OCR forecast, which had the OCR unchanged at 1.75% all the way through to the end of 2019.”

Turner said at the time, the forecast was to emphasise the balance risks to the outlook.

“At the upcoming meeting, the RBNZ may agree the balance of risks has changed and it is appropriate for the RBNZ to provide some guidance on when rate hikes will likely take place.

“But the RBNZ is likely to be unhappy with where market pricing currently is and the impact that pricing is likely having on holding up the [New Zealand dollar].

“Hence the RBNZ’s’s communication challenge: despite the improvement in the economic outlook and move in risks around the inflation outlook, the RBNZ may still need to sound very dovish if it wants to send a message to market participants which have completely got ahead of themselves.

“This Thursday, much focus will be on both the RBNZ’s language as well as the end point of its OCR projection.

“Although the OCR may not move, we could see some significant volatility in financial markets if the RBNZ takes a soft stance and succeeds in getting its message through.”