Reserve Bank may affirm pace of rate hikes to market expecting less

Reserve Bank governor Graeme Wheeler

The Reserve Bank may surprise some market participants by reiterating plans to lift the official cash rate by 200 basis points over two years in next week's policy statement, in the face of surging migration, a weaker kiwi, stimulatory fiscal spending and a growing economy.

Governor Graeme Wheeler will lift the OCR by a quarter point to 3.25 percent next Thursday, according to 16 of 17 economists in a Reuters survey. The rate reaches 3.5 percent by year end, based on the median expectation.

Since the central bank's March monetary policy statement, figures have shown inflation accelerated a lower-than-expected 0.3 percent in the first quarter, while there are signs heat in the housing market is dissipating, at least partly in response to curbs on low-equity loans. That's helped stoke expectations that the tightening cycle will be less severe than suggested in the last MPS.

Yet annual net migration is expected to peak at close to 40,000 this year, more than three times the long-term average, while last month's budget added $500 million a year to government spending and the trade-weighted index this week fell to a three-month low of 78.58, reducing the impact of a high kiwi in mitigating imported inflation.

"Compared to the March MPS, the RBNZ might sound a touch less worried about inflation and the forecast of 90-day interest rates might be downgraded by 10 or 20 basis points," Westpac Banking Corp chief economist Dominick Stephens said in a MPS preview. "But this will be detail around the edges – the main point of the document will be to communicate that further hikes are coming."

By contrast, financial markets are expecting a softer tone, and one of the central bank's key aims next week could be "to bring errant financial market pricing back into line with its own thinking," Stephens said.

That's a view shared by Kymberly Martin, senior market strategist at Bank of New Zealand, who says swap rates have declined from their peaks of recent months and appear to be pricing in a weaker tightening cycle.

"We believe the market is now complacent on the outlook for the OCR, pricing in little more than 50 basis points of hikes by year-end and just 130 basis points over the next two years," she said. "At next week's meeting we believe the RBNZ will remain committed to raising the OCR by around 200 basis points over this period."

In April, when Wheeler hiked the OCR for a second straight month, up a quarter point to 3 percent, he also nudged up his estimate for gross domestic product in the year ended March 31 by half a point to 3.5 percent, saying the economic expansion "has considerable momentum." He also noted that rising net immigration was boosting "housing and consumer demand."

ASB chief economist Nick Tuffley is forecasting total net immigration will peak at 42,500 this year, equivalent to adding a city larger than Wanganui.

Still, he expects Wheeler to pause after next week's expected OCR hike until late 2014, partly because immigration is boosting the supply of labour, which should weigh on wages, and because Fonterra Cooperative Group has flagged a cut in its milk payout for next season.

The reduced milk payouts would all up take about $2.6 billion out of the domestic economy in the next 18 months, amounting to about 1.1 percent of gross domestic product, according to Con Williams, rural economist at ANZ Bank New Zealand.

Gross domestic product for the first quarter is scheduled for release on June 19. Given the Reserve Bank raised its expectation for first quarter GDP to 3.5 percent, there is scope for the bank to lift its second-quarter projection next week, which sat at 3.5 percent in the March MPS.

(BusinessDesk)

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