Reserve Bank governor Adrian Orr kept the official cash rate at 1.75 percent as widely expected but said he now expects to keep rates on hold for at least a year longer than previously thought and reiterated the next move could be up or down.
“We expect to keep the OCR at this level through 2019 and into 2020, longer than we projected in our May statement. The direction of our next OCR move could be up or down,” said Orr in the monetary policy statement.
The New Zealand dollar fell to 66.99 US cents as at 9.40am versus 67.46 US cents just prior to the statement. The two-year swap rate fell almost 6 basis points to 2.05 percent.
The central bank’s forecasts now show the OCR lifting to 1.9 percent in September 2020 versus a prior forecast of September 2019. A full-rate hike is now signalled by December 2020, when the benchmark rate is forecast to be 2 percent. The central bank had previously signaled it would reach that level in March 2020.
The Reserve Bank is charged with keeping annual inflation between 1 percent and 3 percent with a focus on the mid-point and with supporting maximum levels of sustainable employment within the economy.
Orr said there are “welcome early signs of core inflation rising” and he expects inflation to increase toward 2 percent over the projected period as capacity pressures bite.
“This path may be bumpy, however, with one-off price changes from global oil prices, a lower exchange rate, and announced petrol excise tax rises expected. We will look through this volatility as appropriate, and only respond to any persistent movements in inflation,” he said.
The central bank’s forecasts now see annual inflation hitting the 2 percent midpoint in March 2021 versus December 2020 in the May projection.
The consumers price index rose 0.4 percent in the three months ended June 30, while annual inflation was 1.5 percent. However, there were emerging signs of wage inflation in recent labour data as the impact of a lift in minimum wage kicks in and migration continues to slow.
All 16 economists polled by Bloomberg expected the OCR to remain on hold at a record low 1.75 percent today and the median of 11 expect rates to lift to 2 percent by the third quarter of 2019.
“We continue to expect that the OCR will stay on hold until November 2019, though the RBNZ’s new view is it will be on hold for longer. The important thing is that there is absolutely no urgency for the OCR to increase for a considerable period,” said ASB Bank chief economist Nick Tuffley. He expects inflation to be higher than the central bank expects and “the RBNZ is likely to end up lifting the OCR earlier than its current forecasts imply.”
One of the key reasons the central bank now expects to keep rates on hold for longer is moderating economic growth. The RBNZ lowered its short-term growth forecasts but does see gross domestic product picking up faster toward the end of the forecast period, underpinned by fiscal and monetary policy stimulus.
It now expects GDP to accelerate to 2.9 percent in the March quarter of 2019 versus a prior forecast of 3.3 percent. However, it sees GDP growth at 3.5 percent in March 2020 versus a prior forecast of 3.2 percent.
Government data show the economy expanded 0.5 percent in the three months to March 31 versus a revised 0.6 percent expansion in the fourth quarter and was 2.7 percent higher on the year. The result undershot the central bank’s forecast for 0.7 percent quarterly growth.
“With GDP growth declining, we expect only a gradual increase in inflation. Stimulatory monetary policy remains necessary to ensure inflation continues to rise towards the target mid-point,” the RBNZ said in the monetary policy statement.
According to Orr, there are risks to the central forecast and he said “the recent moderation in growth could last longer.” Also, low business confidence can affect employment and investment decisions.
Overall, the RBNZ said risks to the growth outlook are “tilted to the downside.” The cattle disease, Mycoplasma bovis, is assumed to have a small and short-lived impact on agricultural production.
“If disease spreads more widely than assumed, the implications would be more significant,” it said.
The bank also said international trade tensions could impede global growth and weigh on growth in New Zealand. “An intensification of existing trade tensions is currently the biggest downside risk for global economic activity,” it said.
“If the conflict escalates, the impact on New Zealand would be more significant. The main impact of a trade war on New Zealand will likely be through direct trade channels and uncertainty effects,” it said.
Finally, a tightening in global financial conditions is another downside risk to the outlook.
Regarding employment – given the bank is now mandated with supporting maximum levels of sustainable employment within the economy – Orr said “the labour market has tightened over the past year and employment is roughly around its maximum sustainable level. We expect the unemployment rate to decline modestly from its current level.”
Unemployment was 4.5 percent in the June quarter.
“Overall, employment is estimated to be around its maximum sustainable level and CPI inflation remains below the mid-point of our target range, necessitating continued supportive monetary policy,” the central bank said.