Reserve Bank of New Zealand Statement Possibly Misinterpreted

July 27, 2011

New Zealand’s Reserve Bank kept a 2.5% Official Cash Rate but released a statement that persuaded many analysts to predict a 50-basis point rate hike at the next meeting scheduled for mid-September.  A perusal of the statement, however, reveals three conditions that need to be met to reverse the whole March rate cut, which had come in response to the Christchurch earthquake that struck February 22. 

  1. A softening of the kiwi’s recent high value.
  2. Global financial risks need to recede.
  3. New Zealand’s recovery needs to be confirmed further by upcoming data.

That’s a lot of caveats, and there’s certainly no guarantee that any, let alone all, are met.  None of them involve a far-fetched scenario.

The good news in New Zealand is that growth suffered a smaller post-quake hit than officials feared.  While overall inflation of 5.3% exceeds the 3% target ceiling, it is because of a sales tax hike that will drop out of on-year comparisons in the fourth quarter.  The statement explicitly instructs investors to watch core, not total, inflation, and that is at an in-target 2.5%.  While inflation is less worrisome to officials than one might think, a 2.5% central bank rate can only be justified in the face of a new stall in activity or strong risk of a future stall.

The statement says to me that 1) a cash rate rise in September is conditional on certain named developments and 2) that if the conditions are generally but not convincingly getting met in mid-September, the option of a 25-basis point hike, rather than a full reversal of the March cut, will be considered.  It’s a way of hedging bets.  My third conclusion is that there’s no urgency to get the rate above 3.0% quickly.  The cyclical low of 2.5% was maintained from April 2009 until a 25-bp hike in June 2010.  A second hike to 3.0% was implemented exactly a year ago, and policy had been paused just over seven months when the 50-bp cut was undertaken this past March. 

New Zealand slipped into recession earlier than most economies after the Official Cash Rate was ratcheted up to 8.25% and kept there for a full year, so monetary officials are not bashful about stepping on the brakes hard when they feel such is required.  Today’s statement goes out of its way to dissuade markets from thinking now is one of those times by distinguishing between above-target total inflation and in-target core inflation.  In seven moves, the interest rate was slashed from 8.25% at the start of July 2008 to 2.5% by April 2009.

Copyright 2011, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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