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RBNZ fumbles the pass, misses opportunity to score
Monday, 14 December 2015

Key highlights

The RBNZ cuts the OCR 25 basis points to 2.5%. But lack of a firm dovish bias sees the TWI and rate expectations rise.
The RBNZ is likely to be unhappy with the market reaction, but seems more relaxed on hitting the inflation target midpoint.
US Federal Reserve rate hike expected this week, but focus will be on how many more rate hikes will follow next year.

Report prepared by:

Jane Turner, ASB Senior Economist
Phone: +64 9 301 5853
Email: jane.turner@asb.co.nz

The RBNZ cut the OCR 25bp to 2.5% last Thursday, as widely expected by economists. Although, what was unexpected, particularly for the RBNZ, was the market reaction – the NZD TWI and swap rates lifted on the back of a rate cut. By emphasising both the upside and the downside risks, the market was left a little confused, but mostly unconvinced on the RBNZ’s weak easing bias. And, as a reason for not cutting further at present, the RBNZ cited the section of the Policy Targets Agreement that calls on the Bank to avoid unnecessary instability. Market pricing has moved accordingly. From the RBNZ’s perspective, this was probably not the intended reaction.

Thursday’s announcement was a missed opportunity to nudge the NZD lower – or at least ensure it didn’t rise. The NZD move will make it more challenging for the RBNZ to hit its inflation outlook. The real question is how much will that influence future RBNZ action? The tone of the statement does suggest that perhaps the RBNZ is a little bit more relaxed on inflation getting back to the mid-point. The RBNZ’s inflation projections take 15 months longer for inflation to return to 2%. From the RBNZ’s perspective, in the short-term, just getting into the target band now appears good enough so long as inflation eventually reaches 2% in the ‘medium term’. But the RBNZ is leaving itself little room for error. The three-year moving average of the RBNZ’s inflation forecast (a proxy for the ‘medium term’) is bang on 1% until late 2017 (see Chart of the Week). But we see strong downside risks to inflation. Given the difficulties of inflation targeting once deflation sets in, is undershooting the inflation target band a risk a central bank will take? We think not – eventually. Hence we still expect two further cuts mid-next year.

While all you movers and shakers are out hitting Christmas parties this week, back in the office it is an exciting end to the year for markets and economists. The US Federal Reserve is expected to deliver its MUCH anticipated first rate hike since the Global Financial Crisis. It’s a pretty big deal. The market largely expects a hike, so there will be more interest in what the Fed has to say about the future path for rate hikes. On this front the Fed could be a bit more cautious, which could weigh on long-end rates.

This week another Global Dairy Trade auction and the Government’s Half Year Fiscal and Economic Update take place on Tuesday. Q3 GDP is out on Thursday and this release can be an unpredictable end to the year. Q3 is when StatsNZ put through all its big revisions. We will be back next week with a review of GDP and the Fed announcement, but for those of you heading off on holiday early do have a very merry Christmas and a Happy New Year. Will see the rest of you next week.

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