The Reserve Bank of New Zealand has said it will cut the official cash rate again if necessary. It’s not.
The central bank has two main jobs on the monetary policy front: to support maximum sustainable employment and keep annual consumer price inflation between 1-3 percent over the medium term, with a focus on the mid-point of 2 percent.
Both are ticking along nicely.
No cracks appearing
The RBNZ has repeatedly said employment is at that sustainable level and no cracks are appearing with unemployment at 4.2 percent in the September quarter and wages rising at their fastest annual pace in a decade at 2.4 percent. Data this week showed the services sector added jobs in December and overall confidence in the state of the labour market improved in the final quarter of last year.
On the inflation front, data on Friday will likely show it is a whisker below that mid-point with the median in a Bloomberg poll pointing to an annual 1.8 percent. Regardless, it will probably be above the 1.6 percent tipped by the Reserve Bank.
Not only that, but the fact that the US and China agreed on the first phase of a trade deal coupled with an orderly Brexit will likely help shore up global manufacturing and business investment and commodity prices are holding firm.
Whole milk powder gained 2.4 percent in the overnight Global Dairy Trade auction, which will plump up the already solid farmgate milk price.
Meanwhile, the New Zealand dollar is hovering around 66 US cents, helping support exporters' returns from any market that deals in the greenback.
Looming stimulus
The economy grew 0.7 percent in the third quarter, above the central bank’s forecast for 0.3 percent growth and then there’s the looming fiscal stimulus, including the $12 billion extra infrastructure spend announced late last year.
Central banks traditionally cut rates to jump-start the economy by stoking demand - ergo inflation - with access to cheap credit. In theory, that should boost economic growth by encouraging businesses to spend more on investment, and push along the property market, which in turn leads to greater retail spending as people feel wealthier, even if it's just on paper.
Given the current domestic backdrop and the improving global outlook, why are central bank governor Adrian Orr and his fellow monetary policy committee members even contemplating a cut?
Achilles heel
The Achilles heel for New Zealand's central bank is the interest rate differential across the Tasman. The Australian cash rate is already at 0.75 percent and markets are pricing in two more cuts this year, including a 50 percent chance of a cut on Feb. 4.
The kiwi dollar is already firm against the Aussie, trading at 96.29 Australian cents. If rates were to go to 0.25 percent across the ditch and yet remain at 1 percent in New Zealand, local exporters will feel the pain. Not only that, but parity would be back on the radar.
In saying that, cutting rates is not only unnecessary but could well be counterproductive. Low interest rates have revived the housing market from the lull of recent years and any further cut would only serve to stoke that fire.
Data from the Real Estate Institute of New Zealand shows the housing market ended 2019 on a high note with house price inflation continuing to accelerate in December. The institute's price index hit fresh records both nationally and in all but two out of 12 districts.
Westpac Bank says the boost from low interest rates is “undeniable” and house price inflation was 6.6 percent in the year to December. ANZ Bank expects it to hit 8 percent year-on-year by mid-2020.
Any strength in the housing market tends to spill over into household spending, adding to the argument there's no need for more stimulus. Not only that, an overheated housing market creates a financial stability risk.
Not a done deal
Economists are also coming around to the view that rate cuts aren’t a done deal in New Zealand. ANZ Bank, which had been tipping a rate cut in May, this week said its central forecast is now for a flat track. BNZ sees the Reserve Bank on hold in 2020.
ASB Bank still has a cut pencilled in for this year, but says the odds have reduced. Westpac Bank, meanwhile, no longer expects a cut in the first half of the year.
“We still think that the longer-term risks for the OCR are to the downside and have pencilled in a rate cut for August.”
That might not seem too dramatic but given economists were talking up the possibility of negative interest rates only a few months ago, it’s a sizeable change in view. Let's just hope that the decision-makers are paying attention.
