RBNZ cuts rates, more to come, NZD is a concern - Nomura

Analysts at Nomura noted that RBNZ signals more cuts, but financial stability concerns and NZD to determine the exact timing.

Key Quotes:

"As expected, the RBNZ cut its policy rate to 2.00% and maintained its dovish policy bias, stating that “Our current projections and assumptions indicate that further policy easing will be required to ensure that future inflation settles near the middle of the target range”.

Regarding the outlook for the global economy, the RBNZ observed that “Global growth is below trend despite being supported by unprecedented levels of monetary stimulus”. They also added that “the prospects for global growth and commodity prices remain uncertain” and “political risks are also heightened”, likely a reference to the US election.

On the domestic side, the RBNZ continues to state that growth “remains supported by strong inward migration, construction activity, tourism, and accommodative monetary policy”. However, the bank notes that “low dairy prices are depressing incomes in the dairy sector and reducing farm spending and investment”. The central bank also continues to express concerns regarding house prices, saying that “house price inflation remains excessive and has become more broad-based across regions, adding to concerns about financial stability”.

As expected given the level of the currency, the statement contains a lengthy comment on the exchange rate. The RBNZ notes that “weak global conditions and low interest rates relative to New Zealand are placing upward pressure on the New Zealand dollar exchange rate”. A consequence of the strong NZD is that it is leading to some deflation in tradable inflation and “this makes it difficult for the Bank to meet its inflation objective”. The RBNZ also adds that “a decline in the exchange rate is needed”.

On inflation, the RBNZ said “Headline inflation is being held below the target band by continuing negative tradables inflation”. The central bank also notes that “Although long- term inflation expectations are well-anchored at 2 percent, the sustained weakness in headline inflation risks further declines in inflation expectations”.

In terms of the outlook in the Monetary Policy Statement (MPS), growth forecasts for 2016 and 2017 were revised slightly higher, to 3.4% from 2.4% and to 3.4% from 3.2%, respectively. The upgrade to the 2016 forecast comes despite the weak global outlook, and seems to be the result of the impact of the cut in the policy rate today and the expectation of another cut to come. The inflation forecast was revised lower for both years on the back of the stronger-than-expected NZD.

Overall, today’s decision suggests that another rate cut is very likely. However, given the central bank's concerns regarding the housing market and its impact on financial stability risks, it seems that the next rate cut is not imminent. Nevertheless, we believe that a rate cut is very likely before the end of the year. In terms of timing, we believe it is likely to come at the November meeting, unless NZD depreciates before then.

The NZD has appreciated by almost 1.0% despite the cut, as it seems that some market participants may have been expecting that the RBNZ would surprise and cut by 50bp. Moreover, while the central bank has signalled further cuts, it is only likely to deter the strong carry trade flow into the currency and is likely to continue to appreciate in the short term."