Reserve Bank leaves Official Cash Rate unchanged at 1.75%; surprisingly, no change seen to future interest rate path, with first OCR hike not projected till late 2019; dollar drops sharply

By David Hargreaves and Alex Tarrant

The Reserve Bank now sees the recent softening in house prices continuing and is projecting house price inflation in low single digit figures over the next couple of years.

Additionally, the RBNZ – while not commenting on what it sees happening with mortgage rates over the next year – believes that the pressure on banks to increase deposit rates in order to attract funds will continue.

Interest.co.nz figures would suggest that the recent increases that have been seen in New Zealand in deposit rates have generally been more than matched by mortgage rate rises.

In leaving the Official Cash Rate unchanged at 1.75% on Thursday, the RBNZ noted that “house price inflation has moderated further, especially in Auckland”.

“The slowing in house price inflation partly reflects loan-to-value ratio restrictions and tighter lending conditions,” Governor Graeme Wheeler said.

“This moderation is projected to continue, although there is a risk of resurgence given the continuing imbalance between supply and demand.”

The comments from the Governor are significant, and the first real acknowledgement that the slower housing market conditions – especially in Auckland – since late last year are here for a while.

In the face of continued rampant upward movement in house prices last year, the RBNZ slammed on a 40% deposit rule for housing investors. The move officially took effect on October 1, but in effect was applied by banks from when it was announced in July.

Till now, while acknowledging that conditions in the housing market had softened, the RBNZ had stopped short of claiming anything like victory over rising prices.

Wheeler ‘encouraged’

In the news media conference following release of the RBNZ’s latest OCR decision, Wheeler said the central bank had “been encouraged” by what it had seen in the house market during the past eight months. National house price inflation in the last eight months increased by about 1.5%. In the eight months prior to that house price inflation had been running at about 13%.

“Now if you look at Auckland, over the last eight months, house price inflation has actually fallen by about 1.5% – the eight months before that it had increased by about 14%.

“We don’t know that the moderation we’ve been seeing is going to continue – we think there may be some increase in house price inflation – but nothing like what we’ve seen in the past.”

A significant factor affecting the house market recently on top of the 40% deposit rule has been the fact that the banks themselves have been tightening up their lending and implementing ‘credit rationing’.

Wheeler acknowledged this.

“You’ve seen the banks tighten up their credit policies in terms of lending. You’ve seen an increase in mortgage rates as the banks have had to compete for deposits in order to get their funding – so there are some favourable dynamics out there, if you like, but it remains a significant uncertainty for the forecasts.”

Wheeler would not be drawn on what might happen with bank interest rates over the next year.

‘Some banks approaching their limits’

But he said that what the RBNZ was seeing was that some of the banks were approaching their limits, in terms of their own treasury policies, in the amount of offshore wholesale borrowing they can do.

“They are able to access that pretty easily. You’ve seen the cost of that financing rise over the last six months or so, but they can still access it reasonably easily, but they are getting up against – some of the banks – against their limits.

“So that means they have to look at domestic market for their financing and that’s leading to an increase in competition for deposits and we are seeing an increase in deposit rates. So the banks have essentially been faced with higher costs of funding and that’s been reflected in the adjustment or the increase in mortgage rates that we’ve been seeing so far.

“And I would expect that competition for deposits to continue quite significantly in coming months.”

The RBNZ’s now more benign view of future conditions in the housing market is matched with a ‘dovish’ all-round view of the economy and monetary conditions.

No change to OCR projections

The decision to leave the Official Cash Rate unchanged at 1.75% was expected, but more unexpectedly, the RBNZ is still not forecasting any upward moves in the OCR till late 2019. Based on this ‘dovish’ outlook the Kiwi dollar immediately dropped sharply, down by about US1c to under US68.3c.

The RBNZ has kept its expected OCR track exactly the same as in its February Monetary Policy Statement, with the forecast at 1.8% through to September 2019, before rising to 2.0% in March 2020, where it now remains through June 2020.

Before Thursday’s release, market expectations had been for a rate rise in early 2018, with several local economists in recent weeks bringing their late 2018/early 2019 projections forward closer to the start of next year and suggesting that the Reserve Bank could bring forward the projected track.

This followed stronger-than-expected CPI inflation and employment data and a jump in the RBNZ-led inflation expectations survey. Electronic card spending figures earlier this week also came in ahead of economist expectations.

Economists perplexed

BNZ head of research Stephen Toplis said that recently the country had witnessed rising inflation, rising inflation expectations, falling unemployment, a weakening currency and a strengthening global economy.

“We had thought this would rattle the Reserve Bank. As it turns out, it all seemed to have counted for little as the Bank left its stance unchanged from both its February and March missives,” he said.

“We are not at all surprised that the Reserve Bank left its cash rate at 1.75%; we are not at all surprised that it ruled out a rate increase in 2017; we are not at all surprised that it focused on the transitory nature of some of the price shocks that we have recently experienced. But we are perplexed that the overall stance of policy remains neutral and that there doesn’t appear to be even the slightest nod to a tightening bias.”

ANZ chief economist Cameron Bagrie and senior economist Philip Borkin described the RBNZ’s latest statement as “aggressively neutral”.

“We’re scratching our heads regarding some aspects – the inflation forecasts seem to be testing the realms of credibility, given an economy that is forecast to continue to grow above trend. However, the message from the RBNZ is clear: policy is set to remain on hold for a considerable period and it has no interest whatsoever in pre-empting a policy tightening. We also suspect it is quietly smug about the tightening in policy being applied by the banking sector; a factor underappreciated by the market,” Bagrie and Borkin said.  

ASB chief economist Nick Tuffley said the central bank’s view was “slightly more dovish than expected”.  The RBNZ is projecting a bigger dip in inflation, to 1.1% in 2018, than ASB expects, and the RBNZ’s view of domestic inflation pressures is weaker than in its last forecast.

“We had expected some bringing forward of the implied tightening to the first half of 2019.

“…We continue to expect the RBNZ to lift the OCR in late 2018, earlier than the RBNZ’s current stance,” Tuffley said.

This is the statement from the RBNZ:

Global economic growth has increased and become more broad-based over recent months. However, major challenges remain with on-going surplus capacity and extensive political uncertainty.

Stronger global demand has helped to raise commodity prices over the past year, which has led to some increase in headline inflation across New Zealand’s trading partners. However, the level of core inflation has generally remained low. Monetary policy is expected to remain stimulatory in the advanced economies, but less so going forward.

The trade-weighted exchange rate has fallen by around 5 percent since February, partly in response to global developments and reduced interest rate differentials. This is encouraging and, if sustained, will help to rebalance the growth outlook towards the tradables sector.

GDP growth in the second half of 2016 was weaker than expected. Nevertheless, the growth outlook remains positive, supported by on-going accommodative monetary policy, strong population growth, and high levels of household spending and construction activity.

House price inflation has moderated further, especially in Auckland. The slowing in house price inflation partly reflects loan-to-value ratio restrictions and tighter lending conditions. This moderation is projected to continue, although there is a risk of resurgence given the continuing imbalance between supply and demand.

The increase in headline inflation in the March quarter was mainly due to higher tradables inflation, particularly petrol and food prices. These effects are temporary and may lead to some variability in headline inflation over the year ahead. Non-tradables and wage inflation remain moderate but are expected to increase gradually. This will bring future headline inflation to the midpoint of the target band over the medium term. Longer-term inflation expectations remain well-anchored at around 2 percent.

Developments since the February Monetary Policy Statement on balance are considered to be neutral for the stance of monetary policy.

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