David Hargreaves thinks the Reserve Bank is pushing against gravity – and gravity will win

By David Hargreaves

So, Reserve Bank Governor Graeme Wheeler has put his snooker cue back in the rack and that, as they say, is all folks.

While our central bank has through its public comments left open the possibility of further interest rate cuts next year, its detailed projections in the December Monetary Policy Statement show that it is currently planning on no further moves in the Official Cash Rate – either up or down – between now and December 2018, which is as far as the forecasts go.

I have for a little while been in the camp of those (Westpac has been prominent, more recently joined by ASB) who reckon that the RBNZ will indeed be forced to go lower with rates next year and I’ve seen nothing from the latest MPS to change my mind on that.

On the contrary, I’m now more convinced than ever that the RBNZ will have to drop those rates again.

Probably the ONLY thing that will save the RBNZ from such a course now is the US Federal Reserve. It seems to be a fairly locked in certainty that the Fed will raise its rates next week (and surely all hell would break loose now if it didn’t). Assuming it does, then the statement and supporting commentary that come out along with the decision will be real important.

For our RBNZ to have a chance of holding the line on its current assertion that 2.5% is the low point for our OCR, it will need the Fed to be reasonably ‘hawkish’ on the prospect of further US rate rises next year. I’m not sure it will be, nor can it be, because I think commodity prices – notably oil – are likely to stand in the Fed’s way. If oil prices keep drifting lower, it’s hard to see the Fed being able to maintain an ‘up’ bias for US rates.

The, I think, rather extraordinary references in the MPS document – right at the front – to the Policy Targets Agreement that Wheeler has with Finance Minister Bill English says to me that the RBNZ is piling excuse after excuse for why it will not be meeting its inflation targets.

None of the economists comments that I read after the release of the previous MPS document in September indicated any kind of belief at all that the RBNZ would get within cooee of the inflation projections it made then. At that stage the RBNZ was heroically forecasting 0.7% rises in CPI inflation for both the March and June 2016 quarters. This steroid-fuelled bout of inflation would have seen the RBNZ hit the 2% midpoint of its 1%-3% target by September 2016. 

Move on three months and certainly some reality has bitten. The RBNZ’s now picking a (still quite heroic, I reckon) 0.6% surge in the March quarter followed by a more restrained 0.4% lift in the June quarter. However, the 2% midpoint will not now be hit till December 2017, some 15 months later than the RBNZ thought just three months ago.

I still don’t think they’ve got a show of even meeting those targets – and hence the excuses. I think there’s going to be some pretty earnest discussions between the Governor and the Finance Minister in the early months of next year. A lot will depend on English’s attitude. I suppose if he can be talked into not pushing for inflation to particularly meet the 2% midpoint (which remember is something the RBNZ actually wanted) then the pressure comes off somewhat for further rate falls. But if he does want to meet that target then the pressure will most definitely be on.

The primary reason I don’t think the RBNZ will get close on those inflation targets is that the Kiwi dollar will continue to misbehave – relative to what the RBNZ requires.

The RBNZ’s December forecasts for the future track of the Kiwi dollar are now rather higher than they were in September, but I still think the RBNZ’s going to be very disappointed by what actually transpires. At time of writing the NZ dollar is about 4% above where the RBNZ is forecasting it will be in the March quarter.

Now, a lot can obviously happen in a short time frame, but if the Fed’s message next week is not fairly hawkish then there’s no real immediate reason why the dollar should close the gap between what the RBNZ’s forecasting in three months time and where the Kiwi is right now. Indeed if the Fed goes all ‘dovish’ on us, then the gap could very foreseeably widen.

And of course a lot of importers who will be getting to the end of forward currency agreements at very high kiwi dollar rates now and in January will be able to take advantage of any spikes in the Kiwi dollar – such as the one that has occurred today – to lock in future rates that are considerably better than the RBNZ would have been anticipating. And if they get better Kiwi dollar rates than the RBNZ expects, they don’t have to raise their retail prices as much as the RBNZ expects and inflation doesn’t spike the way the RBNZ expects.

Another great variable is the immigration rate. I think it is going to continue to surpass forecasts for the next 12 months. If it does then this should continue to put downward pressure (as Bill English concedes it has done) on wages – so, another deflationary impact.

The big, big wild card is El Nino. If that’s bad, as it could well be, then it could really hit economic growth next year. And that’s likely to be bad for jobs.

Putting it altogether I don’t see any way that 2.5% could be the bottom for the OCR. I would even now question whether 2% will be the bottom.

The key point will be whether the powers that be decide to effectively throw away the inflation targets next year, coupled with the whole question of how much good can you do by continuing to cut and cut rates. But the fact is we’ve still got higher rates than many other places, so, it’s difficult to avoid the conclusion that we simply will have to do more cutting, inflation targets or not.