The RBNZ is in danger of falling behind the curve but so too are markets. The central bank will raise rates faster than current market pricing suggests, lifting the NZD.
New Zealand’s Dollar could be in for a boost in 2018 if some of the latest interest rate forecasts are to be believed, with the RBNZ likely to begin raising rates almost a year before the market currently gives it credit for.
The New Zealand economy is already running hot, according to some observers, while inflation is knocking on the door of its 2% target and inflation expectations are rising.
Add fiscal stimulus and the record minimum wage increase just pushed through by the government into the mix and the recipe for a rethink and repricing around interest rates may already be there.
“Significant upgrades to growth, low unemployment and forthcoming outsized fiscal spending all demand another hawkish tilt from RBNZ Governor Spencer,” says Richard Kelly, head of global strategy at TD Securities.
New Zealand GDP growth was 0.6% for the third quarter, in line with the economist consensus, although second quarter growth was revised higher from 0.6% to 1% when the numbers were released Thursday.
Furthermore, Statistics New Zealand revised economic growth higher for seven out of the last ten quarters when it calculated the latest figures.
“The quarterly outturn matched TD and the market, but defied the dovish tail of consensus as +0.4% was the favoured forecast for local analysts,” says Kelly. “March year 2016 was upgraded from 2.4% to 3.6% and MY2017 upgraded from 3% to 3.7%. The RBNZ estimate potential growth at around 2¾%.”
Annual inflation reached 1.9% during the same quarter in New Zealand, close to its target, while adjusted measures of inflation that remove more volatile goods are all closing on this level.
“While many local analysts are of the view that forthcoming fiscal stimulus supplements a slowing economy, we do not share that view,” says Kelly.
The coalition government announced a 4.5% increase to the minimum wage Friday which, taking it up to $16.50 per hour, will affect an estimated 164,000 workers and their families. This means around 7% of the NZ workforce just got a pay rise.
Furthermore, the government reaffirmed its commitment to raising the minimum wage all the way up to $20 by the end of 2020 on Friday. This would mark a near 20% increase over just three years.
“Fiscal stimulus is being piled up on top of an economy that is already at breaking point in terms of capacity,” says TD’s Kelly.
Added to this, last week’s budget saw the new government unveil a substantial fiscal stimulus package worth around 3% of GDP over the next four years.
“Inflation and inflation expectations are already at 2% (p2) and are likely to climb higher from here with the lower exchange rate and rapidly rising fuel prices,” Kelly adds.
The budget boasts $5.5 billion of funding for Prime Minister Jacinda Ardern’s Families Package, which is a welfare package containing giveaways for families and low paid workers, as well as $2.5 billion for tertiary education.
The government is also planning to build substantial numbers of new houses. It claims much of all of this spending will be paid for by cancelling tax cuts that had been authorised by the previous government.
“We pencil in the first RBNZ +25bp hike for May 2018, and a follow -up hike in November, for an end -2018 OCR of 2.25%,” says Kelly.
The Reserve Bank of New Zealand is currently host to an interim governor, Grant Spencer, who will be succeeded by NZ Super Fund CEO and former RBNZ deputy, Adrian Orr, in March.
“The Expanded PTA mandate risks compromising the independence of the RBNZ, with the government implying that it is calling the shots on monetary policy,” says Kelly.
It is also the subject of a government review into its mandate, which is seen as likely to result in it being saddled with an obligation to foster full employment, alongside meeting the inflation target.
“We see the mandate to include “maximum employment” being pure populism rather than being driven by an economic imperative i.e. look how well the economy is growing,” Kelly notes.
The review has created uncertainty for markets around the future path of RBNZ interest rates, which has contributed to the weakness of the New Zealand Dollar in recent month.
“Overall, as much as we remain of the view that the RBNZ “should” be trying to get ahead of the curve, we have to wait for the government to clear the way for the proposed mandate and policy process,” says Kelly.
The government’s review is unlikely to conclude until the end of the first half of 2018 and so an interest rate move from the central bank is seen as unlikely before then.
“In terms of risks, we see the potential for later hikes, and more of them, setting up for 2018 being a year of two very different halves,” Kelly says.
Other concerns, which helped drive the NZD to a 6% loss over the greenback during the final quarter, include fears over future growth given the protectionist bent in many of the Labour-led coalition’s policies.
Interest rate derivatives market pricing currently implies the next rate hike from the RBNZ will not come until February 2019.
Any change in this pricing will have the power to drive the New Zealand Dollar higher or lower, depending on where interest rate expectations go.
The New Zealand Dollar saw a mixed session on Friday. It was quoted higher against the majors such as the US Dollar, Sterling, Euro and Yen but lower against the rest of the G10.
The Pound-to-New-Zealand-Dollar rate was 0.16% lower at 1.9046 shortly after the London close.
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