RBNZ OCR Review: RBNZ Cuts Rates On Growth And Credit Crunch Fears

Daily Forex Fundamentals | Written by Westpac Institutional Bank | Jul 24 08 05:45 GMT |

The RBNZ cut the OCR by 25 basis points to 8.00%. The move was aimed at balancing out the recent rise in international funding costs, which could have otherwise led to a de facto tightening. The RBNZ seems prepared to cut again at each review for the remainder of this year. But we think that by early next year, inflation concerns come to the fore again and the easing cycle will be curtailed. The RBNZ cut the OCR by 25bp to 8.00% today, the first move since the 25bp hike in July last year. Like the majority of analysts, we were leaning towards no move until September, but we put the odds on our call at 55-45. Interest rate markets were giving a 70% chance of a cut. In their June Monetary Policy Statement, the RBNZ signalled that they were prepared to cut rates this year, but in a slow and steady manner, until they could get more comfort that inflation was returning within the 1-3% target band. With today's decision, the RBNZ appear to have ditched that approach and are now ready to deliver something more like what markets were hoping for: a series of rate cuts at every meeting for the rest of 2008. Cap'n Crunch So what pushed them into bringing forward their easing plans? The key development was that the global credit crunch has intensified since June, increasing the premium that banks pay for raising funds offshore. The RBNZ has bought into concerns that this will be passed on to the borrowing rates faced by firms and households, leading to a de facto tightening of monetary conditions - in fact, their description of today's move as a 'mitigating effect' suggests that they fear borrowing rates could rise even after this OCR reduction. In that sense, the RBNZ will view today's cut as an 'easing' on paper only. Going for growth The other point we draw from the statement is that growth concerns now dominate the RBNZ's thinking. The press release noted 'more unpleasant international news ... [and] a risk that the domestic economy will slow further'. Remember that in June the RBNZ was forecasting GDP to grow by 0.2% in Q2, whereas all of the leading indicators since then suggest that it will be soundly negative. Beyond this number, though, their outlook for a gradual pickup in activity through 2009 is little changed since June. Inflation was given less weight in the statement, though the RBNZ remains concerned with the outlook. They now expect annual inflation to peak around 5% in the September quarter - all else equal, the surprise in the June quarter CPI last week would have bumped their forecast up to 4.9%, so they must anticipate further pressures on inflation through the current quarter. While they expect inflation to return within the 1-3% target band in the medium term - as their Policy Targets Agreement demands - they no longer think it will be by a comfortable margin. The RBNZ concluded that: 'Provided that the outlook for inflation continues to improve and there is no excessive exchange rate depreciation, we would expect to lower the OCR further.' We don't expect either of these conditions to present a hurdle to further rate cuts. In the first case, the RBNZ views inflation through a demand-driven framework; as long as the economic indicators continue to print soft in coming months, they will continue to look through the cost-driven shock that the economy is facing and will forecast inflation to fall in the medium term. As for an 'excessive' fall in the currency, we suspect the RBNZ has in mind something like early 2006, when the NZD/USD plunged from 0.72 to 0.60 as the market anticipated a series of rate cuts that ultimately weren't delivered. We view such a move as unlikely, given NZ's high commodity prices. One crisis at a time We now expect the RBNZ to cut by 25bp at each review up to January next year. Rescuing growth is on the agenda for now, so annual inflation above 5%, inflation expectations likely to breach 3%, and accelerating wage growth won't be enough to see them pause for breath any time soon. However, we'd put very low odds on a 50bp move at any given review, unless credit market conditions get significantly worse from here. At some point in the future, activity will start to show some improvement, and the RBNZ will have to turn its attention back to the increasingly ugly outlook for inflation. But it's hard to predict exactly when the penny will drop. Our best guess is that the last cut will come in January, leaving the OCR at 7.00%. While this seems like a high 'trough' compared to history, the prospect of higher average inflation in coming years suggests that a 7% cash rate would be close to neutral. Market reaction The NZD has fallen from 0.7500 to 0.7420 since the announcement. This modest initial response will give the RBNZ a lot of comfort. The two-year swap rate fell by 13bp, and is down about 20bp for the day if you count the overnight action. Longer-term rates have fallen by only 3bp, but they are already close to their long-run averages. Short-term interest rates are factoring in a further 130bp of easing over the next year, 25bp more than yesterday. Full RBNZ press release The Reserve Bank today reduced the Official Cash Rate (OCR) from 8.25 percent to 8.0 percent. Reserve Bank Governor Alan Bollard commented that 'more unpleasant international news has emerged since the June Monetary Policy Statement, and there is a risk that the domestic economy will slow further. Moreover, the cost of funds raised abroad by banks has been rising in recent months as the international financial situation has deteriorated. Today's cut will help to mitigate the effect of these increases on the actual borrowing costs paid by firms and households. 'Recent oil and food price increases mean that annual CPI inflation should peak around 5 percent in the September quarter of this year. However, we expect that inflation will return inside the target band in the medium term. The weaker economy is expected to reduce pressure on resources, making it more difficult for firms to pass on costs and for higher wage claims to be agreed. 'Economic activity is likely to remain weak over the remainder of 2008. The ongoing correction in the housing market, together with the very high oil prices, will limit household spending and constrain the extent of recovery. However, high export prices and an expansionary fiscal policy are expected to contribute to a gradual pickup in activity through 2009. 'Consistent with the Policy Targets Agreement, the Bank's focus will remain on medium-term inflation. In this regard, it is important to note that monetary policy has been reasonably tight for some time, and is now restraining activity and mediumterm inflation pressures. Provided that the outlook for inflation continues to improve and there is no excessive exchange rate depreciation, we would expect to lower the OCR further.' Westpac Institutional Bank http://www.wib.westpac.co.nz/ Disclaimer All customers please note that this information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs. Australian customers can obtain Westpac's financial services guide by calling +612 9284 8372, visiting www.westpac.com.au or visiting any Westpac Branch. 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