ASB Economic Update – NZD a Soaring Eagle, not Sinking Kestrel

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Key highlights

  • NZ GDP growth was stronger than expected, though the income story is weak.
  • The US Federal Reserve takes a soft stance on future interest rate increases, pushing the USD down and NZD/USD up.
  • All up, the lack of traction the RBNZ is getting means a 1.75% OCR is now our base case.

Of 3 key events last week one delivered the goods (growth), one was a damp squib (dairy prices), and the last took away the NZ dollar weakness the RBNZ had managed to achieve the previous week (the Federal Reserve). All up, the odds have tipped towards the RBNZ cutting the OCR below 2% at some point this year. We now expect the OCR to reach 1.75% this year.

Q4 GDP delivered the goods, though perhaps we should say the services. Quarterly growth of 0.9% maintained Q3’s pace, meaning the second half of 2015 amply made up for a very muted first half. Strength over the quarter was primarily due to strong business services demand, retail activity, including tourism, and construction. While headline growth appears reasonable and encouraging, per capita income growth remains flat and highlights NZ's economic vulnerabilities going forward. People (migrants and tourists) and stronger debt growth are still playing a key role in driving growth. The dairy auction last week, in contrast, underwhelmed with its overall 2.9% fall and flat wholemilk powder prices instead of the 7% lift dairy futures hinted at. We still expect dairy prices to rise over the course of the next 18 months.

On Thursday morning, the US Federal Reserve undid all the RBNZ’s handiwork in shoving the NZD down. The Fed kept interest rates unchanged, but dialled back its expectations for future interest rate increases by more than expected. The promise of delayed action spurred a dip in the USD to the point where the NZD/USD ended the week higher than it was before the RBNZ’s surprise OCR cut. The trade-weighted NZD is back around the level it sat at in the week ahead of the OCR cut.

Have we already seen the lows for the NZD in this cycle? That could be the case – despite a surprise OCR cut and full pricing for a further cut, the NZD is just not coming down. The aggressive easing actions in Europe and Japan, and the timidity of the Fed are tugging the NZD the other way. The ‘Bird’ as it is also known is certainly proving far more unsinkable than the Kestrel ASB’s market dealers were used to seeing from their window until recently.

All this presents a creeping conundrum for the RBNZ. If the NZD continues its all-too-familiar habit of exceeding RBNZ expectations, then tradables inflation will remain muted. And the RBNZ would need to tug the interest rate lever harder. The problem of generating added stimulus has been compounded by the muted pass-through of the OCR cut to retail lending rates, given a backdrop of rising credit risk premia for banks. The odds have now tipped in favour of a 1.75% low in the OCR. Thus, we now expect two OCR cuts, at the June and August Monetary Policy Statements, with the April meeting a very lineball call for the next move. But the housing market’s response to lower interest rates will remain a consideration for the how much and when.

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21 March 2016