RBNZ To Tighten Again In July, Might Pause Afterwards

Despite recent weak economic data, the RBNZ is expected to raise the OCR by another +25 bps to 3.5% in the July meeting. With second quarter inflation weaker than expected while dairy prices continued to fall, the central bank’s decision in July would be more difficult. Yet, the current level of policy rate has remained stimulatory in the central bank’s perspective and it would not want to hurt its credibility by announcing to pause this month. However, the accompanying statement might be less hawkish and indicate a pause of tightening until December 2014 or January 2015.

New Zealand’s growth appeared to have lost some momentum since the last meeting. Headline CPI rose +0.3% q/q in 2Q14, same growth as in the first quarter but missed expectations. From a year ago, CPI accelerated to +1.6% y/y from +1.5% in 1Q14. Inflation was mainly driven by the housing market but price levels outside of this area had been rather weak. Meanwhile, dairy prices remained under pressure with the Global Dairy Trade auction index falling -8.9% from a week ago on July 15. This was the biggest decline since April 2013 (-11.2%). The index has plunged -35.2% since February’s high of 1482. Indeed, rising global dairy supply is expected to lower exports price for dairy this year. However, the magnitude of the drop has caught market players in surprise.

Worse still, New Zealand dollar has remained strong despite deteriorating export conditions. The NZD has risen more than +5% against the USD since the beginning of the year. In the June statement, the RBNZ warned that ‘the exchange rate is weighing on tradables sector incomes and, together with low global inflation, is keeping tradables inflation low’. It also stated that ‘if the exchange rate remains strong, it is likely to be reflected in continued low or negative tradables inflation’. There have been speculations that the central bank would intervene on the exchange rate after the July meeting.

Notwithstanding the disappointment on the data front, we continue to expect the RBNZ to hike the OCR by another +25 bps. The RBBZ has maintained a front-loaded tightening cycle, meaning the rate hikes would be quicker at first then slow later. The current tightening cycle, begun in March this year, has resulted in rate hikes of +0.75 bps as of June. The central bank should treat this level of policy rate at stimulatory as it believes that the neutral cash rate is around 4.5%. After all, the growth outlook the New Zealand has remained resilient despite slower momentum. It might put the central bank’s credulity at risk if an abrupt pause is made in July. However, we expect a pause after July and the RBNZ would communicate this well in the July statement with references such as the current level of interest rates appear appropriate for now given that the economic backdrop and/or further rate hike would again be needed if inflation approaches the 2% target.

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