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    RBNZ Preview: to cut, or to double-cut?

    The Reserve Bank of New Zealand (RBNZ) is widely expected to cut the official cash rate on Thursday by at least 25 basis points to 3.00%. In fact, every economist surveyed by Bloomberg expects the bank to ease monetary policy, with some even toying with the possibly of a 50 basis point cut, almost bringing the cash rate back to its starting position at the beginning of 2014.

    After successive rate hikes in Q1 and Q2 last year in response to rampant inflation stemming from an overheated property market, the RBNZ entered wait-and-see mode for the remainder of 2014 and most of 2015. This was until last month when the bank decided to cut the official cash rate by 25 basis points after weeks of speculation driven by falling commodity prices and a softer outlook for inflation and growth.

    The same argument is being used to predict an interest rate cut at this week’s policy meeting, but this time there is even more evidence to suggest that the NZ economy is performing worse than was expected earlier in the year. Inflation improved slightly in Q2, jumping to 0.4% q/q from -0.3% q/q, but non-tradables inflation only rose 0.1% over the quarter, its slowest pace since 2009 as consumer confidence continues to deteriorate, and the outlook for trade exposed sector is being hampered by a continuous decline in dairy prices. At GlobalDairyTrade’s (GDT) latest auction dairy prices fell 10.7%, the ninth time in a row that prices have fallen at auction.

    Perhaps the most shocking piece of economic data out of NZ recently was Q1’s GDP report. Seasonal adjusted GDP grew a measly 0.2% in Q1, completely missing an expected 0.6% expansion, as primary industries activity fell 2.9%; lower dairy production and softening activity in the mining sector were to blame. Also, business investment expenditure, a key component of economic development, was very soft.

    The NZ economy is clearly in need of further support, the question is how much support?

    The big factor holding the bank from reducing the cash rate faster is an overheated property market in Auckland, which accounts for around one third of NZ’s total population. Yet, the bank has noted that planned LVR measures should reduce pressure in the housing market, freeing up the bank to loosen monetary policy as it attempts to support economic activity in the broader economy.

    A reduction in the cash rate of over 25 basis points at one time would usually happen at a time of emergency, as was the case during the GFC and the during early 2011. There are similarities between now and 2011, namely the fact the bank is attempting to unwind recent momentary policy tightening, thus it may choose to bite the bullet and lob 50 basis points off the official cash rate.

    Market reaction

    Investors appear to be pricing in around a 110% chance of a 25 basis point cut tomorrow, which means that some believe the bank will cut 50 basis points off the OCR. Yet, most don’t expect that much easing and a cut of that magnitude would like see bears maul the NZ dollar. On the other side of the equation, the kiwi would likely rocket higher if the bank held the OCR steady, but this is very unlikely in our opinion.

    The most likely scenario is that the bank cut interest rates by 25 basis points, in which case the market will be closely eyeing Governor Wheeler’s accompanying statement for clues about the future direction of monetary policy and the bank’s take on recent weakness in the kiwi. A big risk for kiwi bears is the possibly of Wheeler reframing from verbally assaulting the commodity currency and easing the bank’s dovish bias, although this isn’t our base case. We think the bank will verbally assault the kiwi once more and maintain a firm dovish bias, which may result in further NZD weakness.


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