RBNZ Tracker: Why wait?

RBNZ is likely to cut, and soon

Put yourself in Adrian Orr’s shoes.

Only two months ago Orr talked about the possibility of more policy tightening amid sticky domestic inflation. Then the bottom fell out of a bunch of activity proxies.

At the May MPC meeting, the Committee discussed the possibility of increasing the OCR “in the context of persistent domestic inflation, weaker productivity growth, and uncertainty regarding the pace of normalisation in wage and price-setting behaviour”.

But a range of activity indicators - job ads, the PMI and other business survey measures - have deteriorated sharply in recent months. We’d be very sceptical if the weakness was limited to one or two indicators, but it’s not.

The MPC communicated after their 10 July meeting that OCR cuts are coming. The only questions are when and how quickly after the first cut?

“The Committee agreed that monetary policy will need to remain restrictive. The extent of this restraint will be tempered over time consistent with the expected decline in inflation pressures.”

Some market economists now expect the first rate cut in November, with October said to be a lower chance for an easing.

But why wait?

The economy appears to be deteriorating sharply. Housing prices and sales volumes are again declining. Residential construction is also set to fall much further.

Other economists suggest it’s too early for rate cuts because domestic inflation remained too high in the June quarter and it has been weakness in tradable components doing most of the work to lower inflation to date (we covered the Q2 CPI here).

The MPC acknowledged post the July meeting that “[d]omestic inflation measures remain more persistent, but growing excess capacity in the domestic economy provides greater certainty that they will sustainably decline.”

So the MPC is feeling more certain in the non-tradables disinflationary story. We’d also add that the weakness in tradables inflation has increasingly been the result of weak demand, including for consumer durables, so is likely here to stay.

Our reading is that any lingering inflation concerns the MPC have are now taking a back seat to the more worrisome risk of sharp rises in unemployment and overall spare capacity in the economy.

The risk of accelerating unemployment is something that keeps central bankers up at night and will be sending shivers down the spine of MPC members.

So why wait?

The October MPC meeting is nearly 3 months away, and it’s more than four months until the November meeting, after which there isn’t an MPC meeting until February next year.

Our view is that the MPC should cut the OCR by 25bp on 14 August and again in October and November, taking the OCR to a still-elevated 4.75% by the end of the year.

Plenty of room to dial back the OCR which is well above ‘neutral’…

Markets have got the message. AUDNZD has again shot higher since the 10 July MPC statement and the spread between kiwi and Aussie 2-year bond yields has continued to narrow sharply.