Call on OCR cuts but no warning expected from RBNZ

It says the central bank won’t give any warning when it will start – it will be deny-deny-deny-cut.

This is a sensible strategy in a bid to avoid a premature easing in financial conditions that would make it hard to haul a dovish market back from, Sharon Zollner, ANZ’s chief economist says.

From August the ANZ expects the RBNZ to make a steady sequence of 25 basis point OCR cuts taking it to 3.5% over 12 months.

On the bank’s forecasts inflation will be back in the 1-3% band, unemployment will be at 5% and still rising, and the output gap will be deeply negative.

However, Zollner says August is not a strong conviction call, and the risks are roughly balanced on whether the RBNZ starts cutting earlier or later than that.

“There’s still a chance of a hike, either in February if CPI details are ugly, or later in the year if inflation ultimately gets ‘stuck’.”

The murkiness on the call is around a less inflationary baseline than was evident in November – the RBNZ has more runs on the board than they knew, in terms of cooling activity, she says.

With this economic data in the rear-view mirror, the risk of inflation running away again would be much smaller than that of pushing the economy into a state requiring significant stimulus for its revival.

“The risk of holding policy too tight for too long and the costs of potentially easing too soon are by nature asymmetric,” Zollner says. “If you cut a bit late, you just cut faster and hope it comes out in the wash with little harm done. If you realise you have cut too soon, you have to try and haul the market back for a second round of hikes with much bigger swings in rates and potentially damaged inflation-fighting credibility.

“And even just giving the market the green light to price cuts aggressively could see fixed mortgage rates fall meaningfully, easing monetary conditions and giving the housing market a second wind.”

ANZ says it has been upfront about the uncertainty over how this year could pan out. So, what could see the RBNZ cut earlier than August?

• A disinflationary shock, global or local such as trading partner growth, energy costs, severe drought.
• Unemployment and other spare capacity indicators rising faster than the RBNZ expects. The risks appear tilted that way for unemployment, but those around other capacity indicators are more mixed.
• Pricing intentions gap lower, making up for lost time.
• Fiscal policy is meaningfully more contractionary than expected, e.g. cuts to spending are deep and tax cuts are significantly reduced, deferred or cancelled.

Inflation expected to fall further

On the inflation front, Westpac expects it is set to again fall short of the RBNZ’s forecasts.

Westpac expects next week’s update will show that consumer prices rose by 0.5% in the December quarter, leaving them up 4.7% over the past 12 months.

In contrast, the RBNZ’s last published forecasts assumed a 0.8% rise over the quarter - +5% for the year to December.

Westpac senior economist Satish Ranchhod says lower inflation forecast reflects softness in the prices for volatile items like international airfares and food over the past quarter, as signalled by Stats NZ’s expanded suite of monthly price indicators.

The bigger question is what’s happening to the underlying trend in prices. We expect most core inflation measures – including measures of domestic price pressures – will moderate, but remain at levels well above the RBNZ’s target range.

ANZ says it expects the CPI inflation to come in at 0.6%, which would see headline annual inflation to 4.7% and over the next six months a strong supply recovery, previous weak GDP outturns and a deteriorating labour market resulting in rapid disinflation for domestically driven CPI components.

But with forward-looking activity indicators picking up, the RBNZ will remain wary of the risk of a second wind for the economy before persistent inflation is rooted out.