NZ Weekly Commentary 3 November 2014….Westpac NZ Economics
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
|Going nowhere fastAs expected, the RBNZ left rates on hold last week and struck a more dovish tone. With inflation stubbornly low, we think the RBNZ will keep the OCR on hold until September next year.
The RBNZ sat on its hands last week, leaving the OCR on hold at 3.5%.The accompanying statement, as expected, struck a more dovish tone by removing any reference to future hikes. Instead, the RBNZ reiterated that it’s appropriate to continuing watching how inflation evolves.
Looking at inflation, it’s not hard to see why the RBNZ’s stance has softened. Headline inflation in the year to September was just 1%, right at the bottom of the RBNZ’s target band. Some of this is a result of temporary factors, like declines in food prices, which the RBNZ will largely look through. But the more general inflation picture is also soft. Core measures of inflation, which look at the underlying trend in prices, haven’t picked up, and in some cases came down in the September quarter. Businesses are reporting that cost pressures remain low. Finally, recent declines in international commodity prices are threatening to push headline inflation below 1% in the near term.
New Zealand isn’t the only economy experiencing soft inflation. Many of our trading partners are in a similar basket (the notable exception being Australia). But what makes New Zealand an outlier is that our economy has been growing at a solid pace. Through the year to June the economy expanded at a blistering pace of 3.9%. In recent months some of the drivers of growth have moderated, with falls in commodity prices and the earlier tightening by the RBNZ. Nevertheless, the outlook for growth over the coming year is still robust, underpinned by strong construction and population growth. Historically, this sort of growth has presaged strong increases in inflation. But not so this time.
Low inflation and robust GDP growth is an enviable position for an economy to be in. But following four hikes this year, and with inflation at the bottom of its target band, the RBNZ is likely to be nervous.
So, where to next for the RBNZ and the OCR? Reading between the lines of last week’s statement, the RBNZ does expect that the next OCR change will be upwards. In its policy guidance sentences the RBNZ noted that it still expects inflation will rise, which is consistent with a higher OCR. Also, the reference to “further” policy adjustment indicates that future OCR moves will be in the same direction as recent ones – upwards. It is a hiking bias, but one has to peer through a pretty powerful microscope to detect it.
Key to determining the timing of any change in the OCR will be the extent and speed of any pick-up in inflation. We expect that a range of factors, from falling oil prices to lower ACC levies, will dampen inflation over the coming year. This will keep the RBNZ on the sidelines for some time. Our forecast is for OCR hikes to resume in September 2015. At that time the June 2015 CPI will be available, and on our forecasts will show annual inflation of 1.7%.
Financial market pricing is already consistent with a very delayed OCR hiking cycle. However, while there is virtually no chance of an OCR hike over the next six months, we are surprised that financial market pricing has not yet factored in the risk of an OCR reduction over this period. Although this is not our central call, there is a small chance that some unexpected downside event might give the RBNZ reason to reduce the OCR. Market pricing ought to reflect this risk, but currently does not.
On the exchange rate the RBNZ reiterated its earlier warning that the level of the exchange rate is “unjustified and unsustainable” and that it expects a further significant depreciation. We see a heightened risk of intervention in the near future. Hawkish comments from the Fed, combined with the RBNZ’s dovish statement have created conditions under which the RBNZ actually has a reasonable chance of catalysing a drop in the NZD.
The next key pieces of information on the New Zealand economy will be the September quarter labour market data (released on Wednesday). With growth continuing apace, we expect employment increased by 0.8 percent in the September quarter, to be up 3.2% for the year. This would push unemployment down from 5.6% to 5.4% – its lowest level since 2009.
But despite strong employment growth and falling unemployment, wage inflation has not shown any material acceleration since the financial crisis. We expect this to remain the case in the near term, with the LCI expected to show a 2% increase annual private sector wage inflation.
It’s important to put current low wage inflation in context, however. When New Zealand experienced high rates of wage inflation in the late 2000s we also experienced high rates of generalised inflation, eroding households’ purchasing power. Recently, although we’ve had low wage inflation, we’ve had even lower consumer price inflation. Consequently, cost of living adjustments to wages have been modest.
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