September 2008 MPS preview

On Thursday the Reserve Bank is going to take another look at interest rates – and they will also be releasing a new set of forecasts. Like last time, lets try to describe the Reserve Bank’s decision and state what they are likely to do (rather than stating what we think they should do).

Essentially, in a preview to the Thursday meeting we want to ask two overarching questions:

  1. How has economic data panned out compared to the June forecast – and how will this influence the RBNZ’s interest rate decisions,
  2. How has economic data panned out since July (when they cut rates – between forecasts) – and what does this tell us about the potential for interest rate cuts.

Once we have explored this is more detail – we can talk about the likelihood of of the Reserve Bank cutting rates given the net impact of the change in data.

For people that don’t want to read a long boring post, it appears the data from June-July was substantially softer, while data from July-September was stronger. In my opinion, the net impact of data over the past 3 months has made rate cuts more likely – but maybe not to the degree that the market has priced in.

If you want to read my reasoning – have a look below the tab 😉

Changes between June and July

When the Bank’s forecasts were released in June there was one question: If that is your outlook for the economy, why don’t you cut rates now? There response was that they wanted to make sure that the economic situation was softening quickly enough to cause a decline in inflationary pressures – which seemed to indicate that they would look at cutting rates following the labour market data (which would be a September cut).

However, things deteriorated over the next six weeks (between 5 June and 24 July), namely:

  1. Petrol prices rose from $2.01/lt to $2.18/lt,
  2. Consumer confidence collapsed (both the Westpac and Roy Morgan surveys),
  3. Business confidence remained at intensely low levels(*),
  4. Annual CPI growth was greater than expected – however, this was primarily the result of higher than anticipated food and fuel prices,
  5. Retail banks were threatening to lift interest rates – as the cost of credit once again began to climb.

Together these factors were sufficient to push the RBNZ to start its cutting cycle early in July.

Between July and now

The RBNZ put two conditions on further rate cuts in July, namely:

  1. No excessive exchange rate depreciation,
  2. Continued moderation in the inflation outlook (code for continued slowing growth).

With the Reserve Bank of Australia now cutting rates, we have seen a sharper than expected decline in the $NZ against most currencies (excluding the AUS$ of course) – as a result, some mention of this may turn up in the RBNZ’s statement. However, the slump in our currency is, by itself, probably not sufficient to prevent further rate cuts.

As a result, our main concern lies with what recent data tells us about upcoming economic growth – and therefore the outlook for inflation. Over the last six weeks we have seen:

  1. Retail sales collapsed over the June quarter,
  2. Other indicators also pointed out that the June quarter experienced a massive contraction in activity,
  3. House prices have fallen faster as has the outlook for building activity,
  4. World growth outlook (most significantly Australia) has been revised downwards,
  5. Indications of easing world food prices (good for consumers initially – but a threat to our terms of trade boost. In net terms this will be a deflationary factor),
  6. Quality adjusted wage growth was 3.5%, a touch below the RBNZ’s pick, but still in very inflationary territory,
  7. Consumer confidence recovers markedly,
  8. Business confidence recovers markedly,
  9. Petrol prices slid just below $2/lt,
  10. Employment levels recover (and hours worked remain elevated!),
  11. Inflation expectations have shown a sharp increase (although the core RBNZ measure is about inline with expectations).

In net terms – the growth outlook is stronger than it was in July (for post-June), and the potential for greater inflationary pressures are higher.

However, compared to June the short-term outlook is still worse (as June is probably a negative growth quarter, and . As the June outlook was worth 50 basis points of cutting over the year (according to the RBNZ) – the current outlook will deserve a bit more in the Banks view. This makes 3-4 interest 25 basis point cuts over the rest of 2008 extremely likely, and a 25 basis point cut in September is nearly a forgone conclusion.

Do I think they should cut – no, but I’m not trying to say what I think they should do, I am trying to give an idea of what they will do.  It will be very interesting to see their new forecasts.