Staying on course

Following recent sharp falls in oil prices and the related softening in the inflation outlook, there has been speculation about the potential for interest rate reductions by the RBNZ. RBNZ Governor Wheeler used his annual speech to the Canterbury Employers’ Chamber of Commerce to clarify his thinking on this. He effectively poured cold water on the likelihood of near-term rate cuts, noting that the “most prudent option” at the current time is “a period of OCR stability”. This is very much in line with our own view. On our forecasts, the most likely scenario is that we won’t see any change in the OCR until June 2016 at the earliest. So what’s underlying this outlook?

First of all is the current composition of inflation. It’s true that inflation will be very weak in the near term. But this is in large part a result of sharp falls in international commodity prices which the RBNZ looks through when setting policy. This is because OCR reductions to offset the effects of oil price declines that have already occurred may have only a limited impact on near-term inflation. However, they could have unintended and more significant consequences down the track, particularly in terms of conditions in the housing market. In addition, as we’ve seen over the past week, oil prices can swing rapidly. After falling more than 50% last year, prices bounced over the past week, pushing prices at the pump back up by around 10 c/ltr.

More fundamentally, the current softness in inflation is not a reflection of underlying softness in the domestic sectors of the economy. Indeed, the outlook for domestic growth is still firm. This is likely to result in a gradual increase in longer-term inflation, which is the key focus for the central bank when setting rates.

Underpinning this strength in the domestic economy is a strong outlook for housing and construction, particularly in Auckland and Canterbury. Recent building consents data signal that building activity is increasing. However, there is still a way to go before supply catches up with demand. What’s more, there have been continued gains in house prices. Barfoot and Thompson data showed that median house prices in Auckland grew by around 2% (seasonally adjusted) in January to be up 20% over the year. Data from QV showed that prices are also rising in other cities and provincial areas, though to a lesser degree.