Reserve Bank rate cut almost certain this week, even while weaker kiwi stokes inflation

Graeme Wheeler is expected to cut the official cash rate by a quarter point to 2.75% in the quarterly monetary policy statement on Thursday.

See also: RBNZ: Wheeler to cut, to advise, to encourage, and to warn

The Reserve Bank is expected to cut interest rates this week and may again reduce its forecast for economic growth, although the drop in the Kiwi dollar means the bank will probably maintain its projection for inflation to accelerate through the middle of 2016.

Governor Graeme Wheeler is expected to cut the official cash rate by a quarter point to 2.75% in the quarterly monetary policy statement on Thursday, according to all 11 economists in a Reuters survey. Traders see a 78% chance of a cut this week and 38 basis points of cuts in the next 12 months, based on the overnight interest swap curve.

The Reserve Bank has dialled back its estimate of annual economic growth this year to 2.5% from 3% and economists say the bank may lower its projections again, given the outlook for global growth has softened, Fonterra Cooperative Group's farmers are facing their lowest payout in a decade and business confidence has turned negative, falling to a six-year low. The jobless rate has climbed to 5.9%.

"While a 25 basis point OCR cut to 2.75% looks to be a done deal, we see a subsequent move to 2.5% as the risk scenario, and below that as unlikely," said Robin Clements, economist at UBS. "Nonetheless, we expect the Reserve Bank to keep its options open by maintaining an easing bias but perhaps making it less forceful."

A bigger adjustment is likely to the Reserve Bank's forecast track for the trade-weighted index, which has sunk to about 68.61, a level the bank hadn't expected to be breached over its forecast horizon through 2017. At the June MPS, the bank had projected an average level for the third quarter of 74.7.

Mr Clements cites a Wheeler speech from July, where he said Reserve Bank modelling suggests "that a 1% exchange rate depreciation boosts annual CPI inflation, albeit with a considerable lag, by around 0.1 percentage point."

The TWI's decline so far this quarter could add 0.6%age points to the inflation path, as it lifts the value of imports, so that "even with downgrades to other aspects of the inflation outlook, inflation is still likely to be forecast to be close to the mid-point by the middle of next year," he said.

The kiwi has fallen on expectations the US Federal Reserve will begin hiking its benchmark from near zero this year. US payrolls data came in weaker than expected, with 173,000 workers added in August, but the unemployment rate fell to 5.1%, a key level for the Fed in deciding whether the labour market has recovered.

Yet the odds of a Fed rate increase at its September 16-17 meeting has fallen to just 30%, according to Bloomberg, which cited futures data.

Westpac Banking Corp's New Zealand chief economist Dominick Stephens says he expects this week's MPS "will strike a slightly more dovish tone than the July OCR Review and speech – that is, the Reserve Bank will sound a little more predisposed to lowering the official cash rate."

Stephens says the OCR could be cut to as low as 2% early in 2016, even though Mr Wheeler used a speech in late July to rein in economists forecasting rate cuts so steep they "could only be consistent with the economy moving into recession."

That speech "created an impression that 2.5% is a 'line in the sand', below which the Reserve Bank will not take the OCR except in recession," Mr Stephens said.

Still, "we remain very comfortable with the idea that, sooner or later, the Reserve Bank will cross the 2.5% threshold," he said. "New Zealand is entering a significant economic slowdown at a time when core inflation is already well below the Reserve Bank 's target, meaning monetary policy has a great deal of work to do." He doesn't see the weaker exchange rate generating enough inflation to offset that.

Inflation expectations are still relatively subdued. In the ANZ Business Outlook for August, firms trimmed their view for inflation in the year ahead by two basis points to 1.68%. The Reserve Bank's quarterly survey of expectations, released last month, showed annual inflation one year out was seen at 1.46%, up from 1.32% in June, and for two years out at 1.94%, up from 1.85%.

But other indicators are stronger. Quotable Value data shows residential property values rose at their fastest annual pace in eight years in August, led by Auckland, where values increased 20.4%, outpacing a 13.9% rise in the national average value for urban areas. Meanwhile, annual net migration rose to a fresh record in the year ended July 31, with the arrival of a net 59,639 permanent or long-term migrants, up from 41,043 a year earlier.


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