ASB Economic Update – Rocky Road

ASB Banner March 29

Key highlights

  • Terror attacks in Belgium have weighed on the GBP as speculation builds that England will leave the EU.
  • We now expect the RBNZ to cut the OCR to 1.75%.
  • Lending rates have not fallen by as much as the RBNZ expected and the NZD remains higher than anticipated.


For a short week, with minimal data releases, there was still plenty of action last week – although not all of it good. Firstly, the unfortunate terror attacks in Belgium caused a knee-jerk reaction in markets around the world with demand rising for safe-haven currencies and assets, while the British Pound fell. While this reaction was relatively short-lived, the impact on the Pound has been longer lasting. The Pound fell following the attacks amid growing speculation that this would encourage more British to vote to leave the EU in the upcoming referendum.

Back in New Zealand, we changed our OCR call last week. We are now calling for a 1.75% terminal rate in the OCR – we expect two more 25bp cuts in June and August respectively (although the risks are tilted to an earlier cut in April). Events since the March Monetary Policy statement show the RBNZ is not likely to get the stimulatory response to the OCR cut that it would have hoped for.

Firstly, several benchmark lending rates have not fallen as much as the RBNZ clearly expected them to. Rising risk premia for banks, particularly this year as European banks have come under pressure, have impacted the costs of raising funds in international markets. This has reduced the amount of pass-through of the OCR to bank lending rates. Secondly, despite the RBNZ cutting the OCR, the NZD remains relatively elevated. Increasingly, the risks are the NZD continues to hold up more than we and the RBNZ had been thinking, and therefore tradeables inflation is likely to be more muted than both of us had been anticipating.

As ever, the RBNZ decisions are event-dependent. Reported inflation, inflation expectations, the broader economic outlook (including May’s labour data) are key events ahead. This week, while there are few NZ data releases, the ANZ Business Outlook includes a measure of inflation expectations. Given the emphasis the RBNZ placed on falling inflation expectations on its rate cut decision, the RBNZ, and now the market, will be watching closely to see how this measure is holding up.

The NZD also remains pivotal to RBNZ decisions; however it is becoming clear the RBNZ can’t expect the Federal Reserve to come to its rescue. Two weeks ago the USD had fallen as the Fed kept interest rates unchanged, but dialled back its expectations for future interest rate increases by more than expected. Last week a number of US Federal Reserve members argued the case for interest rate hikes as soon as April, which pushed the USD higher again. But this week, US Fed Chair Janet Yellen is due to speak on Wednesday morning and, depending on how her speech is interpreted, this could send the USD off in another direction, again. Throughout this, however, the NZD/USD has remained higher than the RBNZ has anticipated.

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