Speculation over new Reserve Bank governor

New Reserve Bank governor Graeme Wheeler will issue his first official cash rate statement on Thursday with the big unknown being how his attitude differs from that of his predecessor, Alan Bollard.

Westpac chief economist Dominick Stephens said in ordinary circumstances, a preview of the OCR would be "incredibly bland".

At the September Monetary Policy Statement, the central bank issued a "firmly on hold" outlook for the OCR. In coming to that view, the Reserve Bank contemplated a weak global economic environment, modest GDP improvement in New Zealand, fiscal austerity, rising house prices, the Canterbury rebuild, low inflation and the excessively high New Zealand dollar.

The economic landscape had changed very little since that time, Mr Stephens said.

"But these are not ordinary times. The Reserve Bank has a new governor and he may interpret the current economic situation differently to his predecessor."

Financial markets appeared to have taken the view the new governor would be more "dovish". Interest rate markets were increasingly pricing in the possibility the OCR would be reduced within a few months, Mr Stephens said.

Experience suggested that the person at the top mattered for monetary policy. The Reserve Bank rapidly changed tack from OCR hikes to OCR cuts soon after the last change of governor, surprising markets in the process.

"For what it is worth, our thinking is that the incoming governor will start his term calmly and cautiously."

The Reserve Bank's target was to keep future inflation close to 2%, on average over the medium term. Mr Wheeler would be presented with a staff inflation forecast that averaged "bang on" 2% for one to three years - the usual target horizon, Mr Stephens said.

The most prudent course would be to keep the OCR on hold and issue a statement ambivalent about future OCR changes. That could be achieved by repeating the last sentence of the September statement: "It remains appropriate for the OCR to be held at 2.5%".

If market speculation was closer to the mark, and Mr Wheeler decided that lower interest rates were appropriate, the October OCR review could be used as a signalling opportunity. On Thursday, the OCR would be left at 2.5% but strong hints of future OCR reductions would be given in the accompanying press release, Mr Stephens said.

Markets were nervous about the OCR review and a reaction of some sort seemed likely. Current pricing suggested a better than 50% chance the OCR would be cut by January, he said.

If the Reserve Bank validated that thinking in any way by hinting at OCR reductions, interest rates could fall sharply on the day.

"By contrast, if our tentative thinking proves correct and the Reserve Bank issues a bland OCR review, interest rates would probably rise slightly," Mr Stephens said.

Labour finance spokesman David Parker said he did not have a strong view on whether the OCR should stay at 2.5% or be cut.

Although New Zealand interest rates were higher than elsewhere in the world, further cuts would reduce the incentive for saving. People were also relying on fixed interest for income and an OCR cut would reduce their returns.

"The outgoing governor at the last OCR announcement said that even if interest rates were cut, the exchange rate would not necessarily drop to reflect the fundamentals of our economy.

"I will be interested to see what Mr Wheeler says in his first outing as governor."

Mr Parker said the OCR should not be the only instrument being considered by the Reserve Bank to help the New Zealand economy suffering from a high dollar.

"But as you know, they are hamstrung by the objectives of the Reserve Bank Act."

dene.mackenzie@odt.co.nz