Little room seen for OCR change

Interest rates will remain in focus for the next few months. Photo: Getty Images
Interest rates will remain in focus for the next few months. Photo: Getty Images
The hurdle for moving the official cash rate either up or down is very high, at least in the first half of this year, BNZ interest rate strategist Nick Smyth says.

The Reserve Bank on Thursday held the OCR at 1.75%, in line with market predictions. Most economists believe there will be no rate change before early 2019, and the Reserve  Bank itself indicates no rate change before early 2020.

Mr Smyth said the central bank was cognisant further rate cuts would generate additional gains in house prices, which could increase longer-term risks to financial stability.

Although inflation was low, the economy was still doing "relatively well" and the unemployment rate was down at 4.5%, the lowest level since 2009.

Other central banks globally were moving to tighten monetary policy, he said.

"That doesn’t mean the Reserve Bank has to follow the crowd, but it probably raises the hurdle for rate cuts. The scenario where the Reserve Bank cuts the OCR is probably one in which a global shock hits."

Although the BNZ had a high degree of confidence the OCR would be on hold in the first half of this year, the outlook later in the year was more uncertain than usual amid changes at the central bank, Mr Smyth said.

Among the changes were former deputy governor Adrian Orr taking over as governor after the March OCR review.

Also, the Labour-led Government was proposing to amend the policy targets agreement and the Reserve Bank Act to formally include employment within the central bank’s mandate, alongside inflation.

The Government was also proposing to shift to a committee structure for OCR decisions at some point. The committee was likely to be made up by a mix of internal bank staff and external members.

"These changes haven’t affected our OCR outlook as yet and we will need to wait until the new governor comes in to get a better sense of how he sees the economic outlook."

Mr Smyth said he expected short-term wholesale interest rates to be "reasonably anchored" this year amid an unchanged OCR.

Only later in the year did he expect the two to three-year rates to start to drift up ahead of when he expected the first rate rise by the Reserve Bank, in February 2019.

More central banks were expected to join the global tightening cycle this year, including the Reserve Bank of Australia. National Australia Bank economists expected the first RBA hike in August and it was possible the market would speculate the Reserve Bank would follow suit.

"For borrowers with a risk appetite, we would consider sticking to floating-rate borrowing rather than hedging at these higher short-term wholesale rates."

Longer-term rates were less influenced by short-term monetary policy factors and more influenced by policy over the next full cycle, along with global forces.

Global interest rates had moved sharply higher so far this year, Mr Smyth said.

The 10-year treasury rate had increased to 2.8%, its highest level in more than three years. The rise in US interest rates had been driven by a combination of factors.

The global economy had improved during the past year and growth was expected to be the strongest since 2011. In the US, economists had upgraded growth expectations after President Donald Trump secured his tax reform plan.

The strengthening in growth came when the US unemployment rate was just 4.1% and wage growth was starting to improve. Market expectations of inflation had risen.

Mr Trump’s tax plan would lead to a wider US budget deficit and the issue of more bonds by the US Treasury at the same time as the Federal Reserve was reducing its purchases of bonds. That meant more supply and less demand from the Fed, Mr Smyth said.

Amid strengthening growth and gradually rising inflation, the market now expected the Fed to raise its cash rate three times this year, more than previously expected. The next rise was expected next month.

The risks around global interest rates were still to the upside, even after the moves seen in the year to date, he said.

"We think there is a reasonable chance the Fed raises the cash rate four times this year, even though our base case is in line with market pricing for three hikes."

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