RBNZ will need more convincing as case for higher rates mounts

by NZ Adviser10 May 2017
(Bloomberg) -- On the face of it, New Zealand’s central bank could be raising interest rates instead of holding them at a record low.

Inflation is above target, the economy is growing at about 3 percent a year and the housing market is overheated. Yet Reserve Bank Governor Graeme Wheeler will keep the official cash rate at 1.75 percent on Thursday, according to all 16 economists surveyed by Bloomberg.

“There’s no excuse for the cash rate to be just 1.75 percent in New Zealand, but no doubt the Reserve Bank will find one,” said Stephen Toplis, head of research at Bank of New Zealand in Wellington. “Surely, at the very least, the bank will be forced to admit that it now has a tightening bias.”

Inflation has picked up much faster than the RBNZ expected, suggesting Wheeler may be under pressure to discard his neutral stance on monetary policy. Whereas the RBNZ said in February the next rate move could be up or down, and it didn’t expect to start lifting borrowing costs until late 2019, investors predict it will start raising them early next year.

In its new set of projections this week, the central bank will have to acknowledge rising inflation pressures by pulling forward its own forecast tightening track, economists say. Yet there are good reasons for Wheeler to be cautious, not least the volatile international environment and indications economic growth won’t be as strong as he predicted.

Once Bitten, Twice Shy?
Furthermore, Wheeler raised rates in 2014 only to be forced to reverse course when price pressures weakened. The bank needs to be sure inflation will hold at its 2 percent goal before it considers lifting rates, Assistant Governor John McDermott said in a Feb. 9 interview.

“We’ve been here before and seen broader inflation fail to materialize,” said Cameron Bagrie, chief economist at ANZ Bank New Zealand in Wellington. Still, “the growth pulse, higher inflation and inflation expectations, a tighter labor market and lower New Zealand dollar make its explicit neutral stance now hard to justify.”

Inflation accelerated to 2.2 percent in the first quarter, much stronger than the RBNZ’s projection of 1.5 percent and the first time since 2011 the bank had achieved the mid-point of its 1-3 percent target range.

While boosted by seasonal influences from food and fuel prices, analysts say price pressures are stronger than appeared likely earlier in the year. A report last week showed two-year-ahead expectations jumped to 2.17 percent -- the highest since late 2014.

A falling jobless rate, rising dairy prices and the New Zealand dollar’s 4 percent decline against its U.S. counterpart in the past three months also point to stronger inflation ahead.

At the same time, economic growth fell short of the RBNZ’s forecast in the fourth quarter, slowing to an annual rate of 2.7 percent. Economists expect growth of 3 percent in 2017, less than the 3.7 percent the RBNZ projected in February.

‘Walk the Tightrope’
And Wheeler may be wary of fanning rate-hike expectations for fear of boosting the kiwi dollar, whose strength in the past has suppressed inflation by damping import prices.

“The RBNZ needs to walk the tightrope of being encouraged by recent developments in inflation, but not so enthusiastic the market brings forward even further its expectations of a hike,” said Nick Tuffley, chief economist at ASB Bank in Auckland. He expects the central bank will continue to predict no change in rates until 2019.

Wheeler in March said policy would remain accommodative “for a considerable period,” and reiterated his concerns about international uncertainties. Since then, credit conditions have become tighter and lenders have raised mortgage interest rates, which has helped take some heat out of the property market. And despite falling unemployment, wage inflation remains subdued.

“We see a minimal risk of inflation running away on the RBNZ,” said Zoe Wallis, chief economist at Kiwibank in Wellington. “The bank can afford to sit on its hands and wait.”

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