Lack of inflation, higher kiwi suggest RBNZ rate cut next week

The Reserve Bank will probably lower the official cash rate to 2.5% next week, and may signal the end of the current easing cycle, because inflation is weaker than expected, the kiwi dollar is higher, and the central bank envisaged one further reduction after it cut in September.

Governor Graeme Wheeler kept the benchmark interest rate at 2.75% at his October 29 review, saying "some further reduction in the OCR seems likely" to ensure annual inflation returns to the mid point of its 1-3%  target range. Thirteen of 14 economists in a Reuters survey expect he will cut the OCR by a quarter point next week, then hold the rate unchanged until the first quarter of 2017, when he expected to raise the rate back to 2.75%.

Mr Wheeler would reach his inflation target by the third quarter of 2016 based on the projections in the September monetary policy statement but since then there have been signs price pressures have fallen away and the trade-weighted index, at just under 72, is sitting about 6% above the 67.9 average level the bank assumed for the fourth quarter, reducing imported inflation. A cut next week would allow Mr Wheeler to deliver a Christmas present to exporters, businesses and households, while no change could push interest rates and the kiwi higher.

"Given the benign outlook for domestic inflation, a desire to maintain downward pressure on the exchange rate and the bank's likely assessment of the risk profile, we expect the RBNZ will retain an easing bias following the rate cut we expect next week," said Darren Gibbs, chief economist at Deutsche Bank, in his MPS preview.

Still, Mr Gibbs said he expects "the RBNZ's formal interest rate projection will imply no more than a chance of a further rate cut, contingent on the assumption that the exchange rate resumes a downward trend."

Economists expect inflation to undershoot the Reserve Bank's September MPS forecast of 0.2% for the final three months of 2015. Westpac Banking Corp forecasts a quarterly decline "closer to -0.2%" because of lower prices for petrol and food prices, and general weakness in retail prices.

Mr Wheeler will have to weigh up the risks of adding fuel to the housing market via lower borrowing costs, with overheated prices in Auckland already having a ripple effect on neighbouring regions from home buyers looking for somewhere affordable to live.

Prices of dairy products are higher than where they were at the time of the September MPS and whole milk powder gained 5.3% in this week's GlobalDairyTrade auction to US$2,260 a tonne, although it is still short of the US$3,000 a tonne Fonterra Cooperative Group has said is needed to support its current forecast for the 2015/16 season of $4.60 per kilogram of milk solids. Fonterra reviews that forecast next week. The ANZ Commodity Price Index slid 5.6% in November, led by dairy products after two months of gains.

Some readings of the New Zealand economy are more upbeat. Business confidence rose to a six-month high in November. The BNZ-BusinessNZ performance of manufacturing index was at 53.3, seasonally adjusted, in October, while the performance of services index was at 56.2. Both were above the 50 reading that separates expansion from contraction.

A net 14.5% of businesses were confident about the general outlook for the economy over the coming year, up from 10.5% last month, according to the ANZ Business Outlook survey.

Westpac's "Ready Reckoner" report, which assesses the likely impact on the Reserve Bank's 90-day interest rate forecast of various "shocks" or surprises that have hit the New Zealand economy since the last MPS, puts the net change at just five basis points (bps). The September MPS had the 90-day bank bill rate levelling out at 2.6% by September next year, from 2.91% currently. The biggest weighting in the Westpac analysis was given to the stronger TWI, seen shaving off 25 bps. That's offset by 20 bps of gain from higher house prices, 15 bps from higher export prices and 5 bps from migration. Near-term economic growth is counted as 5 bps.

The Reserve Bank will be making its interest rate call a week ahead of the key Federal Open Market Committee meeting, which is expected to result in the first increase in the federal funds rate since it was cut to between zero and 0.25% in December 2008 to support an economy reeling from the sub-prime mortgage crisis that precipitated the global financial crisis.

(BusinessDesk)