ASB Economic Update – RBNZ won’t lose focus on slipping inflation expectations

ASB Banner May 23
Key highlights

  • Land use regulations may be contributing to a squeeze in Auckland housing affordability.
  • Softening in longer-term inflation expectations likely to press the RBNZ into delivering a further rate cut in June.
  • Fonterra’s opening forecast for the upcoming season due, informal market expectations centred on $4.60 per/kg.

Affordability of housing in Auckland was in the news last week with political calls for the city’s urban limit to be abolished. The vast price differential between land just within the boundary and land just outside highlights the strong influence that planning limits have on housing affordability. Last week we put out our second Home Economics Report, in which we looked at several other fast-growing international cities that – like Auckland – have high house prices compared to incomes. Restrictive land use regulations were one thing these cities have in common with Auckland. At the other extreme is Houston, Texas, which has relaxed land use regulations and low house prices relative to incomes. Although there will be other costs to light regulation (such as the potential for sprawl and for added infrastructure costs), the housing affordability contrast is stark.

This week’s Budget will be watched for any housing-related measures, among many other things. Numbers-wise, we expect Budget 2016 to show that the Government’s books remain healthy. The Budget may signal a reduced deficit to end the 2016 fiscal year. In addition, the Government’s books are still likely to show a modest improvement over Budget period, with the OBEGAL to lift towards 2% of GDP by 2020. While the Government continues to have fiscal room, it is likely to keep its powder mostly dry in this Budget.

High Auckland house prices are a concern for the RBNZ through its financial stability mandate, and an argument against further interest rate cuts. But, perhaps tugging the RBNZ in a different direction, we judge that the RBNZ’s concerns about low inflation expectations have got a little larger. Last week the RBNZ’s Survey of Expectations showed that the 2-year inflation expectations was quite steady at 1.64% - still near a record low but at least not falling any further. But other less high-profile inflation expectations measures point to some softening in long-term inflation expectations. Given how spooked the RBNZ was back in March over falling inflation expectations, we believe ongoing concerns over inflation expectations will swing the RBNZ into cutting the OCR in June. But a cut at that particular meeting is becoming more of a 50:50 proposition, and is muddied even further by the Federal Reserve June 15 meeting now looking ‘live’ for an interest rate hike. The RBNZ may hold fire in the hope the Fed does some work in pushing the NZD down, before it delivers the OCR cut its forecasts call for.

Preceding the Budget, at the start of Thursday, Fonterra will release its first milk price forecast for the 2016/17 season. We expect Fonterra’s forecast to be largely in line with the prevailing market view. An informal market survey is sitting at around $4.60/kg, although risks are skewed to a slightly higher opening forecast ($4.80/kg) in order to support farm cashflows (see our preview for more detail).


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