Tepid inflation expectations in future rate cut equation   11 Aug 2016

Paul McBeth

Article - BusinessDesk

Thursday 11 August 2016 10:06 AM

RBNZ's Wheeler juggles strong kiwi, tepid inflation expectations in future rate cut equation

By Paul McBeth

Aug. 11 (BusinessDesk) - Reserve Bank governor Graeme Wheeler signalled another interest rate cut will follow today's quarter-point reduction, and that he may need to plumb ever-lower depths if the kiwi dollar continues to fly against projections or inflation expectations stay muted.

Wheeler reduced the official cash rate 25 basis points to 2 percent and said the bank's current projections "indicate that further policy easing will be required to ensure that future inflation settles near the middle of the target range." The bank lowered its forecast track for the 90-day bank bill rate, seen as a proxy for the OCR, predicting it will fall to 1.8 percent by the June quarter of next year, 30 basis points lower than its projections two months ago.

"The high exchange rate is adding further pressure to the export and import-competing sectors and, together with low global inflation, is causing negative inflation in the tradables sector," Wheeler said in a statement. "This makes it difficult for the bank to meet its inflation objective. A decline in the exchange rate is needed."

The RBNZ signalled a rate cut was imminent in an unexpected statement last month that "further easing was likely" as a strong currency made it hard to meet its mandated target of keeping inflation between 1 percent and 3 percent over the medium term. Consumer prices rose an annual 0.4 percent in the June quarter, its seventh quarter below the band with the strong kiwi's deflationary effect being compounded by last year's slump in oil prices.

The central bank pushed out its timeframe for returning headline inflation to its 2-percent midpoint target by a year, lowering the annual outlook for consumer prices by about half a percentage point until late next year. At the same time, it hiked its outlook for the trade-weighted index - it now sees the TWI averaging 76 this quarter, from its previous forecast of 71, and then holding above 75 through the December 2016 to June 2017 quarters. In June it had expected the TWI to fall close to 70 over that period

The kiwi jumped as high as 73.41 US cents after the monetary policy statement was released, from 72.02 cents immediately before, with traders disappointed Wheeler wasn't as aggressive as he could've been. It was recently trading at 72.64 cents.

The kiwi dollar has been a thorn in the central bank's side by making imports cheaper, and if the RBNZ's assumption that it will depreciate doesn't emerge Wheeler will have to cut interest rates even more. In an alternative scenario, the bank projects the 90-day bank bill rate falling to 1 percent if global growth and inflation stay weak, meaning New Zealand's interest rates stay attractive for longer

The bank's other concern is if inflation expectations decline further than they have already and become embedded into long-term projections, which "would be concerning and potentially costly to reverse." If that were to occur, the bank projects the 90-day rate could fall below 1.5 percent.

Wheeler again noted house prices were rising at an "excessive" pace, though new macro-prudential tools to limit riskier lending were seen as mitigating the threat to the financial system.

The bank's growth forecasts were kept largely intact, and Wheeler said the domestic economy was continuing to be supported by strong inward migration, tourism, the construction sector, and low interest rates. Still, farm spending was down due to low dairy prices, and the increased labour supply meant wages stayed subdued.

(BusinessDesk)

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