RBNZ OCR Preview: Accentuate the Positive
OCR on hold for now at 8.25%, but RBNZ to confirm hawkish stance
RBNZ still in "wait and see" mode.
Expect a hawkish tone, albeit with acknowledgement of the weaker housing market.
Inflation is headed north; brace for more hikes in 2008.
The Reserve Bank was handed an awkward PR problem this week when government policy changes knocked some 0.3 percentage points off the Q3 CPI outturn, making inflation for the quarter a very tame 0.5% (1.8%yr). It's a hard sell justifying interest rates at 8.25% and a NZ dollar over USD0.76 when CPI inflation is sitting dutifully below the middle of the target band and the housing market looks to be screeching to a halt faster than expected.
Nonetheless, we think the RBNZ will give it a good go next Thursday.
The Government's recent policy changes, affecting prescription charges and early childhood education fees, are exactly the sort of one-off price
changes that the Reserve Bank is entitled – indeed obliged – to look through, according to its Policy Targets Agreement. And focusing on the medium term, there are plenty of economic positives to accentuate, to explain inflation pressure. However, PR problem #2 is that these positives are birds in the bush rather than in the hand. The $3.6 billion of extra dairy cash (a startling 2.2% of GDP) is a done deal, but will not start to flow seriously into pockets until the last couple of months of this year. A fiscal lolly scramble next year was made more certain by the recent announcement of yet another accidentally enormous government surplus, but it remains an abstract concept at this stage.
The economic headwinds, on the other hand, are in our faces already: a sharply slower housing market, particularly the higher-risk end such as Auckland apartments, and obvious downside risk from still-fragile sentiment in international credit markets.
On balance, we are expecting the economy to truck along quite nicely, though the aggregate numbers will mask very disparate fortunes: between dairy farmers and apple growers; rural and urban; exporters and importers; borrowers and savers. The main point is that huge economic stimulus is hitting NZ at a time when the economy is already very stretched. The unemployment rate remains at near-record lows, and wage growth is high and set to accelerate. The loud sucking sound coming from the mines of Australia isn't helping. Surveyed capacity utilisation remains very high, and firms are reporting rising costs, and intentions to raise their prices. Oil and more general commodity prices are rising, along with transport costs. Rents are likely to take off as landlords demand compensation for higher interest rates and little capital gain. World food prices are going ballistic, with the dairy boom just the vanguard. A year ago, it was all about housing. Now, the inflation pressures are much more pervasive. Even with the housing boom on its wobbly last legs, the RBNZ hasn't yet gotten inflation beat.
The Reserve Bank will remain firmly on hold for now, given the remaining uncertainties about international credit markets, and questions around how far the housing market might fall. But by next year, with inflation sitting just outside the target band and looking buoyant, it will be clear that still-tighter monetary conditions are required. We anticipate two further hikes in the first half of 2008, though the timing depends on the behaviour of the NZD.