Markets jolted with reminder OCR cut still possible, sending kiwi, swap rates lower

The New Zealand dollar dropped by about 1 US cent and swap rates fell after the Reserve Bank warned a surging kiwi for no good reason may force a rate cut and said it doesn't plan to budge on the official cash rate this year.

The kiwi sank as low as 81.63 US cents from 82.60 cents immediately before the statement and recently traded at 81.82 cents. That is the lowest level since November 22.

Reserve Bank governor Graeme Wheeler kept the OCR at a record low 2.5 percent for a 16th straight meeting, blaming the overvalued currency and deteriorating drought for "creating difficulty in much of the country".

If the exchange rate climbs "for reasons not justified by New Zealand's economic fundamentals, all other things equal, this would lead to a lower-than-expected OCR", he says in the overview and key policy judgments section of today's statement.

Will create scope

If that "overshooting" in the currency continues, it creates "scope for a reduction in the OCR", Mr Wheeler told media in Wellington. That is due to cheaper imports reducing inflation and a stronger currency diminishing demand for exporters. Conversely, a sharp fall would also prompt a policy response.

The bank sees the currency staying above 75 on the TWI until the June quarter next year, having previously seen it falling below 73 by the end of this year.

"A key factor on the dovish side was a bigger emphasis on the potential for OCR cuts in response to the NZD remaining at recent levels for nine months longer than the RBNZ has factored in," ASB chief economist Nick Tuffley says in a note. 

"Today's statement appears delivered with an intent to bring a bit more balance back into markets by reminding that OCR cuts are a possibility and the NZD is not a one-way bet upwards."

The central bank expects the 90-day bank bill, often seen as a proxy for the OCR, to start increasing in June next year, before accelerating in 2015 and rising to 4 percent the following year. It had previously projected the rate staying on hold until December this year, rising to 3.3 percent in March 2015.

Traders see 22 basis points of cuts over the next 12 months, based on the Overnight Interest Swap curve.

Two-year swap rates dropped 8.5 basis points to 2.83 percent after the release.

David Croy, head of global markets research at ANZ New Zealand, says analysts lowered their expectations for interest rates based on the central bank's 90-day bank bill rate forecast. ANZ is picking a rate hike in the first half of next year.

Dominick Stephens, Westpac Banking chief economist, says the fall in swap rates could lead to a drop in mortgage rates.

"That will stimulate the housing market further – an unhelpful development for the RBNZ." 

Increasing sales

Local property prices rose 7.6 percent last month on increasing sales numbers, according to Real Estate Institute figures. Property market gains have been driven by a lack of supply in Auckland and as the Canterbury rebuild gets under way.

"House price inflation is increasing and the bank does not want to see financial stability or inflation risks accentuated by housing demand getting too far ahead of supply," Mr Wheeler says.

The Reserve Bank estimates house prices increased in real terms at an annual pace of 6 percent last year and will rise 6.2 percent and 3.6 percent this year and the next.

"There is considerable uncertainty around these projections given the nature of supply and demand imbalances in the regional housing markets," the bank says. "We will closely monitor house prices for any signs of feed-through into consumer price inflation."

The bank expects New Zealand's economy to grow at an annual pace of between 2 percent and 3 percent in the coming years on the $30 billion Canterbury rebuild and lift in residential investment. In the December forecast it projected annual growth of between 2.5 percent and 3 percent over the next two years, largely on the back of the Canterbury rebuild.

That growth will be hampered by the drought across much of the North Island, which is sapping the tail end of the agricultural production season, and the government's spending cuts, which will amount to 3.2 percent of gross domestic product over the next four years.

(BusinessDesk)