OCR to stay on hold for some time - Westpac

Analysts at Westpac explained that this week’s Official Cash Rate review from the Reserve Bank didn’t deliver any surprises. 

Key Quotes:

"As expected, the RBNZ keep the OCR on hold at the current record low of 1.75%. In addition, the bottom line of the press release was unchanged from the May Monetary Policy Statement, noting that “Monetary policy will remain accommodative for a considerable period.” Developments since the RBNZ’s previous policy statement in May have been broadly neutral from a policy perspective. While we’ve had lower than expected house price inflation and GDP growth in early 2017, these surprises have been balanced against stronger outlooks for both export earnings and fiscal policy. As a result, the RBNZ’s assessment of overall economic conditions appears to have remained largely unchanged. To generate the sustained rise in underlying inflation pressures that the RBNZ is targeting will require a protracted period of strong activity. And that will require ongoing support from low interest rates for some time yet.

We expect that the OCR will remain on hold through to early 2019. While that’s a little earlier than the RBNZ assumed in their May forecasts (which showed rates on hold until the latter half of 2019), we don’t think this is a big difference. The key point is that we are in for an extended period where the OCR remains very low. However, financial markets more generally expect to see rates rising sooner. In fact, current market pricing is consistent with at least two rate hikes before the end of 2018, with the first coming around June next year. We think this is far too early. It’s true that inflation has picked up.

The Q1 read of 2.2% was not only above the mid-point of the RBNZ’s target band, it was the highest read in five years. However, much of the rise in inflation over the past year has been due to temporary factors. That includes weather related increases in produce prices as well as earlier gains in fuel prices. These factors will reverse over the coming year, and the resulting downturn in inflation will be exacerbated by the recent downturn in oil prices. This means that mid-2018 will see headline inflation dropping back into the lower part of the RBNZ’s target band. The RBNZ does looks through temporary swings in inflation associated with volatility in the prices of items like food and fuel – both to the upside and the downside. Nevertheless, it is tough to make a case for raising rates at a time when inflation is likely to be falling and below the midpoint of the target band.

What’s more important for the OCR is the longer term trend in prices. Looking at measures of underlying inflation in the economy, we see that they have been rising over the past year, but they remain below the 2% target mid-point. Over the coming years, underlying inflation will pick up as the economy continues to expand. But as long as the pickup in underlying inflation remains gradual, and inflation expectations remain well anchored, the RBNZ is unlikely find itself under pressure to raise rates by this time next year. Reinforcing the case for continued stability in the OCR are changes in borrowing rates. Even though the OCR has remained low and on hold for most of the past year, borrowing rates have been creeping higher, and we expect that they will continue to rise gradually over the coming year. Global term interest rates have risen since last year in response to expectations of tightening by the Fed. At the same time, New Zealand's banks are facing higher funding costs as borrowing outpaces deposit growth. Both of these factors reinforce the need for the OCR to remain low in order to support activity."