RBNZ Says More Easing Will Be Needed Even as Economy Booms

  • Economists expect central bank to cut OCR to 1.75% in November
  • Wheeler says strong GDP growth in line with bank’s expectation

New Zealand’s central bank said it intends to cut interest rates again to boost inflation even as its economy grows at one of the fastest clips in the developed world.

“Further policy easing will be required to ensure that future inflation settles near the middle of the target range,” Reserve Bank Governor Graeme Wheeler said in a statement in Wellington Thursday, after holding the official cash rate at 2 percent. The RBNZ has indicated it prefers to change rates in conjunction with quarterly forecasts, which are next due Nov. 10. 

Record-low borrowing costs are fueling a housing boom and helped economic growth accelerate to 3.6 percent in the year through June. So far they haven’t managed to revive inflation, which is being held below the bottom of Wheeler’s 1-3 percent target band by the strong New Zealand dollar.

“It remains a case of the RBNZ operating in an environment full of tension,” ANZ Bank New Zealand chief economist Cameron Bagrie said in a note to clients. “Traditional policy signals are arguing for no further stimulus or even less, but are going head-to-head with the likes of the strong New Zealand dollar, fragile global economy and low inflation.”

No Favors

The currency fell slightly after the RBNZ’s decision and bought 73.33 U.S. cents at 5:10 p.m. in Wellington. It was boosted earlier when the U.S. Federal Reserve left its policy interest rate unchanged for a sixth straight meeting.

Janet Yellen isn’t doing Wheeler any favors -- the kiwi has climbed more than 14 percent since mid January, supported by the Fed chief’s reluctance to raise rates.

Weak global conditions and low interest rates relative to New Zealand’s are placing upward pressure on the local dollar, which is higher than the RBNZ assumed in its August forecasts, Wheeler said today. He reiterated that “a decline in the exchange rate is needed,” while removing a line from the previous statement that the kiwi’s strength was making it difficult for the bank to meet its inflation objective.

Weak Inflation

Inflation has been below the bottom of the RBNZ’s target band for seven straight quarters and hasn’t hit the 2 percent midpoint it aims for in five years.

Wheeler is worried the longer the gauge stays low -- it’s currently at 0.4 percent and forecast to drop further -- the greater the risk of a deflationary spiral.

“Although long-term inflation expectations are well-anchored at 2 percent, the sustained weakness in headline inflation risks further declines in inflation expectations,” he said in today’s statement.

In August Wheeler lowered the OCR for the second time this year and signaled he intended to cut it at least once more. Today’s decision was predicted by all 17 economists in a Bloomberg survey; all of them expect the RBNZ to lower its benchmark rate to 1.75 percent in November, and eight see a reduction to 1.5 percent early next year.

Investors today increased bets on a November rate cut, pricing a 69 percent probability, according to swaps data. The odds fell to 50 percent last week after strong economic growth figures were published.

Goldman’s Call

The growth report, which showed household spending expanding at the fastest pace in four years, prompted Goldman Sachs Australia chief economist Tim Toohey to cancel his forecast for two further RBNZ reductions. New Zealand’s economy is “too strong to justify further rate cuts,” he said.

A recovery in global dairy prices may bolster growth, which is already faster than the RBNZ expected. Fonterra Cooperative Group Ltd. on Wednesday raised its forecast milk payout for the second time in a month, responding to signs that a three-year price slump is coming to an end. Dairy products are New Zealand’s biggest export.

“It is worth remembering that the main problem facing the RBNZ in the last few years has not been growth,” said Paul Bloxham, chief economist for Australia and New Zealand at HSBC in Sydney. “The problem has been that solid growth has not generated sufficient inflation.”

‘Very Uncertain’

Wheeler put paid to the notion that the strength of the economy might have derailed his easing bias, saying second-quarter growth data were consistent with the bank’s expectations. And though dairy prices have firmed, “the outlook for the full season remains very uncertain,” he said.

The governor said house-price inflation remains excessive, posing concerns for financial stability, but there are signs that recent lending limits and tighter credit conditions are having a moderating influence.

“The growth story in New Zealand is positive, and the dairy sector is seeing some light at the end of the tunnel,” said ASB Bank Ltd. chief economist Nick Tuffley. “But the inflation risks remain skewed to the downside, particularly through the ever-stubborn New Zealand dollar.”

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