RBNZ Predicted to Cut Interest Rates in December as Inflation Expectations Wane

New Zealand interest rates could fall again in December as the Reserve Bank of New Zealand anticipates slowing growth trends in 2016.

ASB Bank have told clients they expect the economy to grow at an annual rate of 2.1% early next year, having hit over 3% in early 2015.

"However, a lower NZD and lower interest rates should help lift growth back up to around 2.7% by the first half of 2017,” say analysts who are forecasting the Reserve Bank of New Zealand (RBNZ) to cut interest rates again with an initial cut coming as early as December.

The call comes as the New Zealand dollar takes a dip on the back of observations inflationary conditions in the country are weakening. Lower inflation essentially opens the door to further rate cuts at the RBNZ as the primary danger of lower rates is higher inflation. The RBNZ's quarterly poll shows business managers expect inflation will be 1.85 percent in two years time, compared with 1.94 percent in the previous period.

Of additional concern to the RBNZ will be the performance of New Zealand’s dairy sector which is experiencing contraction at the present time.

Low dairy prices have resulted in farmers reducing their production, as limited cash flows and poor growing conditions in the spring will erode profit margins.  

Concerning the dairy sector’s outlook ASB say:

“The dairy sector will drag on growth this year. We expect a sharp 6% drop in production and a pull-back in investment and discretionary spending. The small recovery in dairy prices since mid-August lifted farmer spirits off their lows, but dairy incomes will remain under heavy pressure this season. El Nino is an additional downside risk as we head into summer.

“We expect dairy prices to get worse before they get better. Dairy buyers have yet to feel the supply pinch. With EU production still growing and global dairy inventories high, buyers are in no rush. As a result, we expect prices to fall at this week’s dairy auction.”

A Few “Bright Spots”

Non-dairy exports such as tourism, retail trade (which feeds off of strong tourist numbers), and a stronger than expected construction sector are providing “bright spots” in a slow growth economy.

On these points, ASB forecasts, “While Chinese growth is slowing; we anticipate demand for most NZ exports will remain resilient as NZ exports generally reflect the structural lift in household disposable incomes rather than the weakening Chinese investment cycle.

“Overall domestic demand remains moderate with strong migration (population growth) and increased consumer purchasing power offsetting weak drivers such as low confidence. Looking ahead, lower interest rates should continue to underpin moderate domestic demand.

“Canterbury consent issuance, particularly non-residential, shows there remains plenty of rebuild demand in the pipeline. Residential consent issuance has lifted throughout the country. We expect that construction growth will slow this year, but the level of construction activity will remain very high.”

Increasing Slack in Labour Market, RBNZ to Cut Interest Rates

As labour demand declines, due to sluggish growth, the unemployment rate will likely increase in the coming months.

However, net migration remains robust. Therefore, ASB expects “the excess of workers will help keep wage inflation modest and contribute to muted domestic inflation pressures”.

ASB goes on to predict, “Inflation pressures are likely to remain subdued and remain in the lower half of the RBNZ’s 1-3% target band. Tradable inflation may temporarily lift over the coming year, reflecting the lower NZD.

“However, we expect a muted pass through to retail prices given the ongoing highly competitive retail environment. Accordingly, we expect a 25bp OCR cut this December and see potential for further cuts over 2016.”