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New Zealand Dollar Returns to the Doldrums after RBNZ Cuts Growth and Inflation Forecasts

“We don’t foresee an OCR hike until late-2019. If anything, we would put the odds of an OCR reduction this year as slightly higher than the odds of a hike,” - Westpac. 

The New Zealand Dollar reversed much of its January rise against the US Dollar and charted a return toward an 18 month low against Sterling Thursday after the Reserve Bank of New Zealand slashed its forecasts for economic growth and inflation.

Forecast changes came alongside the Reserve Bank’s decision to hold the cash rate at a record low of 1.75% for the 15th month in a row, and have further dimmed market hopes of an interest rate rise from the RBNZ later in 2018.

The Reserve Bank cut its GDP growth forecast for New Zealand in 2018 from 3.8% to 3.1% after having revisited its assumptions on the amount of fiscal stimulus likely to be provided to the economy by the new Labour led coalition government.

Labour’s maiden budget, delivered in December, includes more than $8 billion of additional government spending over the life of the current parliament, which is worth up to 0.5% of GDP in each year.

However, after having seen the budget, the Reserve Bank expects less stimulus for the economy in the short term and more in the long term, which is why it lowered the 2018 growth forecasts at Wednesday’s meeting.

Expectations for growth in 2019 and 2020 were raised by a touch, although not by enough to improve an uninspiring inflation outlook.

“If we are correct, GDP growth this year and next will fall short of the RBNZ’s expectations. Consequently, we doubt that non-tradables inflation will accelerate to the extent that the RBNZ expects,” says Dominick Stephens, chief economist at Westpac.

In addition to lower growth, the bank’s all-important forecasts for inflation showed a lower level of likely price pressures prevailing throughout 2018 and 2019, dealing a blow to traders betting that an interest rate rise will come sooner rather than later.

“Inflation has spent most of the past six years below the mid-point of the RBNZ’s target range, and is still too low for comfort. With other countries around the world also experiencing persistently low inflation, there seems little prospect of tradables inflation correcting this,” Stephens adds.

Wednesday’s inflation forecast changes left the headline consumer price index below the midpoint of the RBNZ’s 1% to 3% target range in 2020, when they had previously shown CPI hovering at the midpoint throughout much of 2018. This is a substantial deterioration of the inflation outlook.

“The lower projection in today’s MPS is influenced by the Bank’s assumption for the trade-weighted exchange rate (TWI), which for the next year is about 2% firmer than that assumed previously,” says Suan Teck Kin, CFA, head of Research at UOB Bank in Singapore.

The lower inflation forecasts are a bad omen for those who had thought the bank could be convinced to raise the cash rate later this year and an even worse development for the New Zealand Dollar, seeing as they are primarily the result of currency strength rather than economic weakness.

New Zealand’s Dollar had risen by more than 3% against the US Dollar this year, while holding its ground against Sterling and the Euro. It has risen against all three currencies over a three month horizon.

“We find calls for OCR hikes this year to be well off the mark, and consider market pricing for a hike around the turn of the year to be too eager,” says Westpac’s Stephens.

“We don’t foresee an OCR hike until late-2019. If anything, we would put the odds of an OCR reduction this year as slightly higher than the odds of a hike, although a large shock would be required to generate either.”

Pricing in interest rate derivatives markets, which enable investors to protect themselves against changes in interest rates, showed on Wednesday that investors and traders were expecting an interest rate rise no later than March 2019. 

However, by Thursday morning, this pricing had shifted to show that markets now expect an interest rate rise will not come before May 2019. 

In addition, Wednesday saw those same markets assign a 20% probability to the notion that the RBNZ might raise rates in August 2018 but, by Thursday morning, this implied probability had fallen to 10%.

Still too much, according to Westpac.

Wednesday's RBNZ announcement marked what is one of acting Governor Grant Spencer’s final meetings as head of the bank, before the incoming Adrian Orr takes over as at the end of March.

Given the pending changeover at the top, and that NZ interest rate decisions are still made by the governor and the governor alone, a change in the RBNZ’s stance toward current monetary policy settings cannot be ruled out for the months ahead.

However, a change for the better is probably unlikely because an ongoing government review of the central bank’s mandate remains another drag for markets.

This review is expected to culminate in a new “dual mandate” later in 2018, which would see the RBNZ obligated to target full employment alongside its inflation target.

The review itself could suggest a concern within government that interest rates might rise before the labour market is sufficiently improved and wages growing again.

However, that being said, this week saw the New Zealand unemployment rate shown falling to a near decade low of 4.5% for the fourth quarter, when economists and financial markets had expected it to rise by a touch. In addition, wages also grew at a healthy clip.

The NZD/USD rate was quoted 0.28% lower at 0.7207 during early trading in London Thursday while the Pound-to-New-Zealand-Dollar exchange rate was up 0.25% at 1.9245.

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