The November Monetary Policy Statement (MPS) from the Reserve Bank of New Zealand (RBNZ) is released on Thursday. Since their last full MPS in August both growth and inflation have surprised to the upside. Despite that, we expect the RBNZ will hold the line on no change in rates for the foreseeable future, and that the next move could be up or down.
It’s a safe bet to assume no change in interest rates when the next MPS comes out, which once again makes it all about the messaging. The recent message has been about risks to growth, especially given the dark mood pervading the business community and concerns about renewed downside risks to inflation. That has resulted in an interest rate projection path that sees no change in interest rates until 2020, along with a balanced set of risks around which the next move in rates could be up or down.
Furthermore, alternative scenario modelling by the Bank indicates they would respond more aggressively should downside risks to growth manifest (with 100 bps of cuts) than they would be if inflation surprised to the upside (50 bps of hikes).
Since they put their last set of projections together, both GDP growth and inflation have surprised to the upside. The Bank was expecting 0.5% for June quarter GDP, which printed at 1.0% showing broad-based strength. They were expecting September quarter inflation of 0.4%, but it came in at 0.9%.
The accepted wisdom has been to largely dismiss the strong growth number as historical, and that weak business confidence may yet have a more meaningful impact of hiring, investment and growth more broadly.
Looking ahead, we think growth holds up okay, largely driven by fiscal stimulus and stimulatory monetary conditions. Over the next few quarters our growth forecasts are broadly in line with the RBNZ’s, meaning the 0.5% upside surprise in the June quarter will get banked as stronger growth.
The surprise on inflation was for mostly ‘non-core’ reasons, ie factors the RBNZ will tend to “look through” such as petrol price and excise increases. That said, non-tradeable inflation was higher than expected over the quarter, with the annual rate now at 2.6%.
Our take on the economy is that we are now in the more challenging phase of the economic cycle. The easier growth that comes as spare capacity is gradually absorbed has turned to the hard grind of capacity constrained growth.
That should result in a combination of lower growth and higher inflation. The first part of that equation is well entrenched, but we still wait patiently for more of the latter, especially in respect of core inflation.
We expect headline inflation will be in excess of 2% with the release of December quarter data in January and continue to move higher until the middle of the year June 2019. We also expect core inflation will remain subdued but continue to trend gradually higher reflecting capacity constraints, particularly in the labour market (more news on that on Wednesday), and already tight margins that will get stretched further by higher fuel and wage bills.
We saw the risks around the RBNZ’s interest rate projections shifting through time. Initially the risks were to the downside if growth disappointed. Our view is that growth will come in okay. That means the risks shift to the upside as capacity constrained growth puts upward pressure on inflation.
But for now the Bank will hold the line that downside risks to growth are still present, that core inflationary pressures will remain low, and that the risks to the outlook of no change in interest rates for the foreseeable future are evenly balanced.
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