As expected the Reserve Bank of New Zealand hiked the Official Cash Rate (OCR) 0.25% to 3.5% today. Most interest today however was in the messaging around where to from here. In that respect the RBNZ signaled a “period of assessment before interest rates adjust further towards a more-neutral level”. In other words, it’s time for a cup of tea.
Recent economic data has been biased to the soft side. Most recently we saw a further large fall in dairy prices in the global dairy auction and a softer than expected CPI. That followed falls in business confidence, albeit it still at healthy levels by historical standards. On the other side of the equation net migration has remained strong which is putting pressure on the housing market.
And of course all of this has been occurring at a time when the exchange rate has continued to be strong. I have long been at the hawkish end of monetary policy expectations, but always acknowledged the key role the exchange rate would play in determining the phasing and ultimate extent of the interest rate cycle.
As I said last week we are now at a point where the softer data, especially commodity prices, along with the continued strength in the exchange rate does not fit with continued hikes in the OCR. Something had to give.
While I am of the view that we have passed the peak in quarterly growth rates, I continue to expect growth to be stronger than our non-inflationary potential. That means pressure on resources and upward pressure on prices. I therefore still see a strong case for interest rates to be at least back to neutral in time. And remember when the exchnage rate eventaully falls that will in itself contribute to higher inflation.
The key question now is how long a pause will this be? At this point I expect the next hike in December, but that will be exchange rate and data dependent. The risk to that view is the pause is longer. The reality is we don’t expect sustained downward pressure on the NZD until we see upward pressure on the AUD and USD. That needs rate hikes (or at least firmer expectations of rate hikes) in Australia and the US – and that’s a 2015 story.