Reserve Bank leaves Official Cash Rate unchanged at 1.75%; still forecasting interest rate rises from late 2019 onwards; dollar gains slightly

By David Hargreaves

The Reserve Bank as expected kept the Official Cash Rate unchanged at 1.75% in Governor Graeme Wheeler’s last interest rates decision in the job.

Perhaps more surprisingly, in its latest Monetary Policy Statement the central bank retained its previous forecasts that interest rates will start to rise from late 2019.

Also worth noting in the forecasts are that economic growth from next year onwards is now expected to be slightly stronger than previously, inflation is forecast to be weaker and the Kiwi dollar is forecast to be stronger.

Late last year the RBNZ implemented a 40% deposit rule for housing investors to try to take heat out of the housing market. The housing market has indeed softened this year.

‘I’ll be giving a speech’

In his last press conference as Governor, Wheeler dead-batted questions about his time as Governor and meeting inflation targets by saying he would be giving a speech at a later date at which such questions would be covered off.

Wheeler said house price inflation continued to moderate due to loan-to-value ratio restrictions, affordability constraints, and a tightening in credit conditions. 

“This moderation is expected to persist, although there remains a risk of resurgence in prices given continued strong population growth and resource constraints in the construction sector.”

Given recent soft inflation data coming out, some economists had expected the RBNZ to possibly push out the timing of rate rises.

The Kiwi dollar rose slightly on the news and was US73.5c a short time ago.

ASB’s view

ASB chief economist Nick Tuffley said the RBNZ’s OCR outlook was not as ‘dovish’ as expected.

“We had seen a good chance the RBNZ would push out the point at which its forecasts showed increases.”

Tuffley said the RBNZ’s inflation outlook in its latest forecasts now dips more sharply in 2018 (to 0.7% yoy), reflecting recent food and fuel price movements. The longer-term view is roughly similar to the May forecasts.

Comments made by the Governor, Tuffley said on the New Zealand dollar were largely similar to those made at the time of the last Monetary Policy Statement in May, though rearranged to put more weight on the need for the NZD to boost tradable inflation.

The RBNZ has recently put a lot of emphasis on understanding better why inflation has not increased in the manner that its economic forecasting models used historically would suggest it should. The central bank hiked interest rates a full percentage point in 2014 in response to perceived emerging inflationary pressures, which proved illusiory. 

Changes in inflation seen

In the latest MPS the bank says its recent research to understand the drivers of low domestic inflation found evidence of a change in domestic price-setting behaviour over recent years.

“Generally, businesses are assumed to set prices using a combination of past inflation outcomes and future inflation expectations as a reference,” the RBNZ says.

“This research suggests that, in recent years, businesses have been placing a greater weight on past inflation when setting prices.

“In response, the Bank has adjusted its forecasting models of inflation to better capture the role of past low inflation weighing on current pricing decisions.

“This has helped remove the negative forecast errors in non-tradables inflation observed between 2012 and 2015.”

The RBNZ says the implication from its research is that recent weak pricing dynamics are likely to act as a headwind to inflation over the forecast horizon.

This suggesed that the stance of monetary policy “needs to be more accommodative than otherwise”.

“There is a risk that price-setting behaviour could be stronger than is currently assumed in the forecasts. If businesses begin to put less weight on past inflation when setting prices, recent low inflation outcomes would weigh less on the outlook for inflation. This would lead to higher inflation as pricing behaviour responds relatively more to economic activity and to expectations of higher future inflation. In this situation, less policy stimulus would be required for CPI inflation to settle near the mid-point of the target band.”

Here is the statement from Wheeler:

The Reserve Bank today left the Official Cash Rate (OCR) unchanged at 1.75 percent.

Global economic growth has become more broad-based in recent quarters.  However, inflation and wage outcomes remain subdued across the advanced economies, and challenges remain with on-going surplus capacity.  Bond yields are low, credit spreads have narrowed and equity prices are at record levels.  Monetary policy is expected to remain stimulatory in the advanced economies, but less so going forward.

The trade-weighted exchange rate has increased since the May Statement, partly in response to a weaker US dollar. A lower New Zealand dollar is needed to increase tradables inflation and help deliver more balanced growth.

GDP in the March quarter was lower than expected, adding to the softening in growth observed at the end of 2016.  Growth is expected to improve going forward, supported by accommodative monetary policy, strong population growth, an elevated terms of trade, and the fiscal stimulus outlined in Budget 2017.

House price inflation continues to moderate due to loan-to-value ratio restrictions, affordability constraints, and a tightening in credit conditions.  This moderation is expected to persist, although there remains a risk of resurgence in prices given continued strong population growth and resource constraints in the construction sector.

Annual CPI inflation eased in the June quarter, but remains within the target range.  Headline inflation is likely to decline in coming quarters as the effects of higher fuel and food prices dissipate.  The outlook for tradables inflation remains weak.  Non-tradables inflation remains moderate but is expected to increase gradually as capacity pressure increases, bringing headline inflation to the midpoint of the target range over the medium term.  Longer-term inflation expectations remain well anchored at around 2 percent.

Monetary policy will remain accommodative for a considerable period.  Numerous uncertainties remain and policy may need to adjust accordingly.