Shock Therapy Needed for Kiwi If RBNZ Wants Inflation to Fly

Reserve Bank of New Zealand Governor Graeme Wheeler News Conference

Graeme Wheeler.

Photographer: Mark Coote/Bloomberg
  • RBNZ seen cutting rates Thursday and signaling more to come
  • ‘Just meeting market expectations is no longer enough’: ANZ

New Zealand central banker Graeme Wheeler is going to need more than a plain-vanilla rate cut if he wants a weaker local currency.

Investors are certain the Reserve Bank will reduce its official cash rate Thursday by at least a quarter point to 2 percent, a record low, and most expect it will deliver another cut to 1.75 percent by November, swaps data show. That means Wheeler needs to signal he’s prepared to take the OCR lower than that, or drop it by half a point this week in one hit, to engineer a sustained decline in the kiwi, analysts said. The market was pricing a 20 percent chance of a half-point cut late Tuesday in Wellington.

“He would have to surprise the market, and that will be difficult because so much is now priced in,” said Imre Speizer, currency strategist at Westpac Banking Corp. in Auckland. “A rate cut alone won’t do anything. The key will be guidance.”

If Wheeler wants a primer on the risks he can look across the Tasman Sea to Australia, whose dollar is the best performer across the Group of 10 currencies this quarter even after policy makers cut interest rates there to a record-low 1.5 percent.

Wheeler has said he wants a weaker currency to boost import prices and drive inflation back into his 1-3 percent target band -- a goal he’s undershot for seven straight quarters. His problem is New Zealand’s benchmark rate remains well above those of its peers, attracting foreign investment and buoying the kiwi. 

At 71.4 U.S. cents, the exchange rate is as high today as it was in June last year despite five rate reductions in that period, because other central banks have eased policy too and the U.S. Federal Reserve has delayed raising its benchmark further after one increase to 0.25-0.5 percent late last year.

‘Almost Irrelevant’

“My view on the New Zealand dollar is pretty much predicated on the U.S. outlook; the RBNZ is almost irrelevant,” said Jason Wong, currency strategist at Bank of New Zealand in Wellington. “It’s all about what’s happening offshore.”

Recent policy decisions abroad have illustrated the need for central banks to surprise markets to get the desired result.

The Reserve Bank of Australia last week cut its key rate only to see the Aussie dollar rally because it didn’t signal an explicit intention to ease policy further. The Bank of Japan also boosted the yen July 29 when it failed to step up stimulus as much as markets expected.

By contrast, the Bank of England knocked the pound lower Aug. 4 with a more aggressive policy easing than the market anticipated, cutting its benchmark to 0.25 percent and announcing a return to quantitative easing in the wake of the U.K.’s vote to leave the European Union.

Bazooka Not Warranted

“In a world of ultra-loose monetary policy already, just meeting market expectations is no longer enough,” said Cameron Bagrie, chief economist at ANZ Bank New Zealand in Wellington. However, “we don’t favor a BoE ‘bazooka’ style approach; the economy just doesn’t warrant it,” he said.

While New Zealand is not alone in experiencing very weak inflation, with the headline rate currently running at just 0.4 percent, unlike many of its peers it has an economy growing at a healthy clip of around 3 percent a year. It’s also in the grip of a housing boom fueled by record immigration and a shortage of homes, which until now has made the RBNZ wary of lowering borrowing costs further.

The bank last cut rates in March and has warned of the financial stability risks posed by surging house prices. The kiwi’s 7 percent gain since the end of May appears to have prodded Wheeler back into action.

Lending Restrictions

Last month, he announced tighter lending rules for property investors in an effort to cool the housing market and give himself more room to lower rates. Then, in an unscheduled statement July 21, he said the kiwi’s strength was making it difficult for the central bank to meet its inflation target and further policy easing seemed likely.

“A decline in the exchange rate is needed,” Wheeler said.

“The RBNZ is rarely seen as ahead of the curve” and has generally “seemed slow to concede the downside risks to inflation,” said Nick Tuffley, chief economist at ASB Bank in Auckland. “Here is the challenge for the RBNZ this week -- to keep the New Zealand dollar low, it needs to show it’s just as, if not more, willing to cut rates in line with our major trading partners.”

Thursday’s rate decision will be accompanied by a Monetary Policy Statement that includes fresh forecasts for economic growth, inflation and the 90-day bank bill track, which serves as a guide to the outlook for the OCR.

Lower 90-Day Track

“To get the kiwi to fall, my guess is they’re going to need that track to drop by something like 40 basis points, and back it up in the words to give a fairly explicit signal that another rate cut is expected,” said Speizer.

BNZ’s Wong believes Wheeler knows he can’t weaken the kiwi, and can only hope to boost domestic prices to offset the impact of weak import costs. So-called tradables prices, which are impacted by the currency, fell 1.5 percent in the year to June, while non-tradables rose 1.8 percent.

“He’s got to over-stimulate the economy with lower rates and try and get non-tradables inflation higher, that’s the best he can do,” Wong said. “He can’t get what he wants on the currency, and he’s just got to accept that.”

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