Starting with a bang

In its April OCR Review, the RBNZ surprised by advising that "more likely direction of the next OCR move is down." This announcement was followed by broad-based weakness in last week's Quarterly Survey of Business Confidence.

We now expect the RBNZ to cut the OCR in May – the first decision by the newly appointed Monetary Policy Committee. On the back of this change in view we have revised our interest rate and exchange rate forecasts. We now expect the RBNZ to cut the OCR to 1.5% at its next meeting in May. In its April Statement, the RBNZ was clearly getting nervous about the global economic outlook. The fact that foreign central banks are moving towards more dovish monetary policy stances has been particularly important. If New Zealand fails to follow suit, the RBNZ is worried that the exchange rate could rise, putting downward pressure on inflation which is already struggling to reach the 2% mid-point of the RBNZ's target band.

The RBNZ is also becoming increasingly doubtful that New Zealand GDP growth will accelerate to the extent it is forecasting in 2019. Recent data has on that has been mixed. Consumer spending and construction data has been strong but last week's Quarterly Survey of Business Opinion was weak. Not only did headline business confidence fall to within cooee of September's 9-year low, but there was also a broad-based deterioration across most of the key activity and investment indicators. Profits are being squeezed by rising costs and a perceived inability to pass these on to customers, increasing the chances that weak confidence will become self-fulfilling. The survey suggests March quarter GDP growth is likely to be around 0.5%. That's weaker than the RBNZ's forecast of 0.8%, and is consistent with an economy that is ticking over rather than picking up.

The labour market leg of the RBNZ's dual mandate gives less basis for cutting the OCR – unemployment is low and as we saw in this week's QSBO, firms continued to report that both skilled and unskilled workers remain hard to come by. And while there has been limited upward pressure on wage growth to date, with the unemployment rate expected to linger around its maximum sustainable level for some time yet, we are expecting to see stronger wage growth this year. But with the maximum sustainable level of employment still relatively uncertain, the employment target is unlikely to get in the way if a modest OCR reduction is warranted on inflation grounds.

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