OCR cut outlook shifts

In his speech, Reserve Bank governor Graeme Wheeler said that responding to low inflation with immediate interest rate cuts was not the right approach.

Adopting a mechanistic approach could lead to a fixation on headline inflation and a flexible approach to interpreting the Policy Targets Agreement (PTA) was a better approach, he said.

While he didn’t rule out OCR cuts, he emphasised that further easing would only happen if the RBNZ’s concerns over certain economic risks, such as the global outlook, deepened.

Westpac chief economist Dominick Stephens said Wheeler’s speech was encouraging for his long-held view that the RBNZ will reduce the OCR to 2.0% in 2016.

But it was also discouraging for the idea that the first OCR reduction could occur as soon as March, he said.

“Overall, the Reserve Bank sounds ready to cut the OCR if necessary, but not itching to do so.”

In his view, the upshot was that the RBNZ would be more likely to reduce the OCR if the global economy worsens, prices for key exports fall, or inflation expectations fall.

“Housing market data over February and March was also mentioned: the RBNZ would be more comfortable reducing the OCR if the Auckland housing market’s recent slowdown becomes a trend.”

Stephens said that Westpac’s call for the OCR to fall to 2.0% in 2016 fits in well with the scheme Wheeler laid out in his speech.

“We made that call in July last year on the basis of our assessment that inflation was not on track to reach two percent on average over the medium term.”

Slowing economic growth and the possibility that inflation expectations could fall further meant that call was still valid, he said.

Just before Wheeler’s speech, new labour market figures, which showed there was a significant drop in unemployment – from 6% to 5.3% - in the December quarter, were released.

This data ran counter to the market expectation that there would be a slight lift in the unemployment rate.

It has also prompted a number of economists to say the possibility of an OCR cut in March is low.

ANZ senior economist Philip Borkin said the data means that, from a monetary policy perspective, there is clearly no unemployment rate smoking gun for a lower OCR.

“It reduces the odds of an OCR cut in the near-term and we’d go so far to say as it rules out March completely.

“Instead, we see the figures justifying a continuing watchful stance from the Reserve Bank.”

ASB economist Kim Mundy agreed the employment data meant an OCR cut in March is now unlikely.

“We still expect that the Reserve Bank will cut the OCR 50bp this year, from June. But the low unemployment rate is an argument against a cut as soon as March.

“The Reserve Bank might want to wait for the May labour release to get a better handle on what is happening with labour force participation.”