OCR reduced today

The Reserve Bank today reduced the Official Cash Rate (OCR) by 25 basis points to 2.5 per cent.

According to a Reserve Bank release, globally, economic growth is below average and inflation is low, despite highly stimulatory monetary conditions. Financial markets remain concerned about weaker growth in emerging economies, particularly in China. Markets are also focused on the expected tightening of policy in the US and the prospect of an increasing divergence between monetary policies in the major economies.

Growth in the New Zealand economy has softened over 2015, due mainly to lower terms of trade. Combined with increases in the labour supply from strong net immigration, the slowdown has seen an increase in spare capacity and unemployment. A recovery in export prices, the recent lift in confidence, and increasing domestic demand from the rising population are expected to see growth strengthen over the coming year.

The NZ dollar has risen since August, partly reversing the depreciation that occurred from April. The rise in the exchange rate is unhelpful and further depreciation would be appropriate in order to support sustainable growth.

House price inflation in Auckland remains high, posing a financial stability risk. Residential building is accelerating, and recent tax and LVR measures are expected to reduce housing pressures. There are some early signs that Auckland house price inflation may be moderating.

CPI inflation is below the one to three per cent target range, mainly due to the earlier strength in the NZ dollar and the 65 per cent fall in world oil prices since mid-2014. The inflation rate is expected to move inside the target range from early 2016 as earlier petrol price declines will drop out of the annual calculation, and the lower NZ dollar will be reflected in higher tradables prices.

There are a number of uncertainties and risks to this outlook. In the primary sector, there are risks that dairy prices remain weak for longer, and the current El Niño results in drought conditions and weaker output. Risks to the domestic outlook include the prospect of net immigration staying high for longer and of household expenditure picking up on the back of strong house prices.

Monetary policy needs to be accommodative to help ensure that future average inflation settles near the middle of the target range.

The Reserve Bank expects to achieve this at current interest rate settings, although it will reduce rates if circumstances warrant. It will continue to watch closely the emerging flow of economic data.

According to Westpac chief economist, Dominick Stephens, the Reserve Bank does not expect to cut the OCR further, but stands ready to do so if the “economic situation were to change”.

He says the Reserve Bank’s release includes a key phrase that, “We expect to achieve [two per cent inflation] at current interest rate settings, although the bank will reduce rates if circumstances warrant”.

“While this seems to indicate a willingness to cut the OCR further if required, actually the detail of the monetary policy statement portrays a central bank that is reluctant to cut,” says Stephens.

“The RBNZ emphasised the medium-term nature of the inflation target, and by reminding us of clause 4.B of the agreement, which states that the bank must have regard for financial stability when setting monetary policy, and must seek to avoid unnecessary volatility.

“The MPS included four alternative scenarios, with a balance between the upside and the downside.

“The RBNZ discussion of inflation was pointedly focused on core inflation, rather than the low headline rate. Core inflation is currently about 1.5 per cent.

“The RBNZ’s 90-day interest rate forecast was 2.6 per cent, indicating little chance of a further cut.

“The RBNZ may not expect to cut the OCR, but they have said they stand ready to cut if circumstances change. We think the RBNZ will indeed be surprised on the downside by inflation, GDP growth, and house prices – and consequently we remain steadfast in our view that the OCR will fall to two per cent next year. The RBNZ acknowledged early signs that the Auckland housing market is slowing, but suggested this could be temporary. The RBNZ’s house price inflation forecast for 2016 is 10.8 per cent, which we regard as too high. The RBNZ’s forecasts of GDP growth were upgraded materially – the RBNZ’s forecast for March 2017 annual average GDP growth was 2.5 per cent, but is now 2.9 per cent. March 2018 has been upgraded from 3.1 per cent to 3.4 per cent. Again, we think this is too optimistic – our own forecasts are 2.2 per cent in March 2017 and 2.7 per cent in March 2018. And our inflation forecasts are a little lower than the RBNZ’s for the year ahead.

“That said, the RBNZ’s current stance does call into question the timing of any move below 2.5 per cent. We are currently forecasting OCR cuts in March and June – we will consider whether this timing remains the most appropriate forecast as we digest the Monetary Policy Statement more fully.”

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