Unlikely prospect of RBNZ rate cut rears head as tightening cycle dissipates

Traders have started pricing in a small prospect of interest rate cuts this year by the Reserve Bank of New Zealand, whose forecasts have overstated the pace of inflation for two straight quarters.

The central bank is seen cutting the official cash rate by 9 basis points over the next 12 months, based on the overnight interest swap curve. Before the bank signalled a pause in its tightening cycle in July last year, some 70 basis points of hikes had been priced in. The direction of the OCR turned negative after figures this month showed the consumers price index fell 0.2 percent in the fourth quarter.

Traders see zero chance of a hike in the official cash rate in this week's policy review and there is widespread expectation governor Graeme Wheeler will tone down or even drop reference to a tightening bias. At his Dec. 11 review, he said some further increase in the OCR "is expected to be required at a later stage," dependent on emerging data. Since then, data has shown annual inflation is below the bank's 1 percent-to-3 percent target range for the first time since the first quarter of 2013.

Wellington-based fund manager AMP Capital (NZ) expects the central bank to lift the OCR in the first half of 2016, reaching a "neutral" level of 4.25 percent by the end of next year. But Grant Hassell, AMP Capital's head of fixed income, says further hikes may not eventuate.

"Personally I think there's a chance that this might be it for this part of the tightening cycle," Hassell said. Rate cuts signalled by the overnight interest swap curve "may be a little bit overdone but it shows the market has changed its mind completely on the RBNZ raising rates any time soon."

The Reserve Bank hasn't cut interest rates since former governor Alan Bollard slashed the OCR to a record low 2.5 percent in March 2011. If the bank found itself in the position of wanting to lower borrowing costs again because of, say, a further slump in commodity prices or a spike up in the kiwi dollar, it would most likely tweak its macro-prudential tools first, given its desire to avoid inflaming the housing market, Hassell said. The kiwi fell to a three-year low 74.05 US cents today.

Economists at Westpac Banking Corp say traders may not have priced in enough prospect of rate cuts even though they see such an outcome as "unlikely, but not unthinkable."

"We would place roughly 20 percent odds on two OCR cuts occurring this year," Westpac chief economist Dominick Stephens wrote in his OCR preview last week. He expects the central bank will tighten macro-prudential policy in 2015, "as falling fixed mortgage rates stimulate the housing market."

Home loan rates fixed for two years or longer fell below variable-rate mortgages last year, hastening the trend for borrowers to fix their mortgages. Banks on average are offering five-year fixed mortgages for 6.61 percent, according to interest.co.nz data, while floating rate loans average 6.72 percent. Borrowing fixed for five years has fallen from as high as 7.31 percent in April 2014. As at November last year, 56 percent of home loans were fixed, up from 43 percent in November 2013 and just 35 percent in the same month of 2012, according to Reserve Bank figures.

Stephens says Wheeler may want to signal a rate cut isn't on the cards, arguing that low inflation reflects temporary phenomena such as falling global crude oil prices, while medium-term inflation may be driven by domestic issues.

"Lower interest rates will surely provide further stimulus to the housing market, raising concerns about financial stability at the central bank," Stephens said. "New Zealand is experiencing above-trend GDP growth, an unprecedented net migration boom, and a construction boom. Not to mention that the past three months of housing market data have been the strongest in a decade."

(BusinessDesk)