Reserve Bank of New Zealand holds interest rate tight

Last of Three Parts

ASB Bank, Auckland, May 15, 2018

The Reserve Bank of New Zealand (RBNZ) has left the Official Cash Rate (OCR) on hold at 1.75% since November 2016, reflecting the ongoing benign inflation environment.

This and the increasingly neutral tone of RBNZ policy assessments have seen markets scale back the timing of OCR hikes, with a full hike not priced until late 2019, consistent with the published RBNZ interest rate projections and ASB’s August 2019 view.

Once the RBNZ does resume lifting the OCR, it is likely to be a gradual process, culminating in a low endpoint this cycle (around 3.50% by 2022).

While OCR expectations have eased, short-term money market rates have nudged up, with the 90-day bank bill rate close to 20bps (basis points) higher than at the start of the year.

Bank bill spreads to Overnight Index Swap (OIS) rates have widened by more in the US and Australia. Our expectation is that NZD spreads will slowly decline towards historical averages.

Longer-term rates tend to be more influenced by movements in offshore interest rates.

The American scene

US 10-year Treasury yields are currently hovering around 3%, a close to 55bp rise over 2018. There have been more sizeable lifts for short-term US rates, with two-year Treasury yields around their highest since mid-2008.

In part this reflects greater conviction that the tight US labour market and rising US inflation will prompt more monetary tightening by the Fed. The three 2018 hikes signalled by Fed are now fully priced in, although markets remain sceptical on whether a further three 2019 hikes will be made (we expect only two).

The New Zealand Dollar (NZD) yield curve has also flattened, and NZD yields have fallen in relation to US counterparts. NZD swap yields are lower than US equivalents out to the seven-year tenor, with 10-year spreads close to record lows.

With the RBNZ on hold, and with the NZ fiscal position in better shape than that in the US, New Zealand bond yields are expected to remain below US counterparts for a little while yet.

Since peaking in mid-April, The NZD is close to 4% lower on a TWI basis.

This is mostly attributable to the strengthening USD, which has risen by 6% against the NZD over that period. Markets are refocusing on yield differentials, with positive (and widening) US spreads supporting the USD.

Currency forecasts

We have changed our currency forecasts, with the USD to remain supported given the slight moderation in global growth over 2018, with the US Federal Reserve is now expected to tighten rates at a faster pace than other central banks.

The NZD TWI is expected to remain broadly supported by NZ’s solid economic outlook, strong NZ commodity export prices, historically-high Terms of Trade and strong demand as global central banks/other real money managers continue to increase NZD exposures.

We expect the NZD to ease slightly over the projection period relative to Euro and Australian Dollar, partly as a consequence of the European Central Bank to contemplate rate hikes in 2019, and the Reserve Bank of Australia hiking rates from February 2019.

The Japanese Yen is also expected to strengthen. Finally, we expect the NZD/GBP to remain just above 0.50 over the remainder of the year, with Sterling past its post-Brexit lows.

Editor’s Note: The above is a slightly edited version of the Quarterly Economic Forecast of ASB Bank, one of the largest commercial banks of New Zealand. This is the third and final part. The first and second parts can be read on our website:


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