RBNZ's high kiwi-hot housing dilemma still in place for next week's MPS

Friday 7th June 2013

Reserve Bank governor Graeme Wheeler faces the same tensions between a high kiwi dollar and a heated housing market that have informed his monetary policy decisions all year and no change is likely at next week's review as inflation stays low.

Wheeler will keep the official cash rate at 2.5 percent when he releases the monetary policy statement on June 13, a level it has remained at since March 10, 2011, according to a Reuters survey of 15 economists. He will raise the rate to 2.75 percent in March 2014 and to 3 percent in June, based on the median estimates.

The trade-weighted index has fallen about 5 percent from its levels a month ago, when Wheeler said the exchange rate was "significantly over-valued."

It was last at 74.61, which is lower than the average of around 75.5 the bank forecast back in March for the first and second quarters but Wheeler said as recently as May 30 that he was prepared to intervene to sell a kiwi that was still 18 percent above its 15-year average. Earlier last month he disclosed the bank's first intervention since 2007.

A strong currency erodes the value of exporters' sales but it also stops imports from stoking inflation, which the Reserve Bank forecast in March would stay below the mid-point of the bank's 1 percent-to-3 percent target range until the third quarter of 2014. The world outlook is mixed, with the Reserve Bank of Australia this week noting that global growth is currently below trend.

"Monetary policy has been in a bind for some time, trapped between rising house prices and the high exchange rate," Dominick Stephens, Westpac Banking Corp chief economist for New Zealand, said in his MPS preview. He expects "a slightly more hawkish tone" in next week's MPS, given that "economic buoyancy has become more intense" in recent months.

House prices in New Zealand are 25 percent over-valued, the International Monetary Fund said last month. Prices rose 9.8 percent in the year ended in April, based on the Real Estate Institute's stratified median housing price index, led by Auckland, where a supply shortage has driven up prices, and Christchurch, embarked on a massive rebuild after the earthquakes.

Last month, Wheeler said pressure in the housing market is posing a risk to financial stability and this week the central bank called for feedback on plans to restrict the volume of low equity mortgages, the first in what is to be a series of macro-prudential tools employed to more precisely target bubbles in the economy.

"Absent signs of an autonomous stabilisation of house prices over coming months we expect to see the RBNZ impose an LVR restriction to bring the proportion of high-LVR lending back down to levels seen 18 months or so ago," said Darren Gibbs, chief economist at Deutsche Bank. "Such a response, whilst primarily motivated by prudential concerns, could have implications for the timing of conventional policy tightening."

Wheeler must balance the economic impetus from the Canterbury rebuild and the wealth effects felt from rising house prices against constrained fiscal spending, a high kiwi and effects of the drought, Gibbs said in his preview. Inflation pressures will build as spare capacity is taken out of the economy, with early bottlenecks likely to include labour costs in the construction sector.

Market traders are betting the central bank will lift the OCR by 22 basis points over the next 12 months, based on the Overnight Index Swap curve. There's zero prospect of a rate hike next week on that basis.

So far this year, economic figures point to an economy that is growing without much inflation, and this week's strong building activity created upside risks for first quarter expansion. Retail sales and employment are growing and Fonterra Cooperative Group has raised its forecast payout for 2014. At the same time labour cost pressures have slowed and firms aren't planning much in the way of price increases.

Westpac's Stephens says there is a risk the market overreacts to next week's MPS as it sifts the words of the statement and digests any changes to forecasts.

"The RBNZ faces the unenviable challenge of delivering a rather complicated message to markets this time," he said. "Developments have leaned in a hawkish direction but this might be offset by macroprudential tools."

BusinessDesk.co.nz

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