MNI ANALYSIS: RBNZ Set to Stay Neutral But More Tilt to Ease

--RBNZ OCR Track May Show 1.8% Through Entire Period

By Sophia Rodrigues

     SYDNEY (MNI) - The Reserve Bank of New Zealand is likely to once again

maintain its outlook for monetary policy but may signal that downside risks to

the official cash rate (OCR) have increased which would make the overall policy

more dovish versus May.

     Any such dovishness would likely come from the way the RBNZ characterizes

the balance of risks. There is also a possibility the RBNZ lowers the OCR track

from 1.9% in late 2019 and 2.0% in early 2020, thus keeping it at 1.8% through

the entire projection period. That should be a hint on how the downside risks

have changed.

     The RBNZ's OCR decision is due Thursday at 0900 local time, and both

economists and the market are unanimous in their view that the OCR will be left

unchanged at 1.75% for the fifth straight meeting. The RBNZ will also publish

its quarterly Monetary Policy Statement, which will contain updated forecasts

and commentary on the economy

     The money market is currently pricing in a 56% chance of a 25 bps OCR hike

by June 2018 and a near-100% chance of a hike by September 2018, with an 80%

chance of two hikes by February 2019. Most economists are forecasting at least

one hike in 2018.

     Like the last MPS in May and the OCR statement in late June, the RBNZ is

likely to maintain the last line; "Monetary policy will remain accommodative for

a considerable period. Numerous uncertainties remain and policy may need to

adjust accordingly."

     But there may be tweaks in its language, with the commentary on inflation

the most important one to look for. Any commentary on the exchange rate will

also be important, especially if the RBNZ makes additional comment about its

impact on inflation.

     New Zealand economic data have mostly disappointed in recent months and

leading that pack is second quarter consumer index inflation data. The data

showed headline consumer inflation was flat q/q in Q2 and +1.7% y/y, slowing

from +2.2% y/y in Q1. The outcome was below MNI median consensus of +0.2% q/q

and +1.9% y/y and also below the RBNZ's projection for +0.3% q/q and +2.1% y/y.

     The RBNZ is likely to view the fall in headline inflation below the

mid-point of its target band as a concern especially given the risk that the

appreciation in the exchange rate could put further downward pressure on

inflation in coming quarters, and the relationship between headline inflation

and wage growth.

     The slowing in inflation contributed to the RBNZ's preferred sector factor

model decelerating to 1.4% q/q in Q2, after remaining unchanged at 1.5% for six

quarters in a row. There was also a small drop in inflation expectations in the

latest survey published by the central bank earlier this week.

     Another key disappointment was a fall in construction activity in Q2, due

to a sharp fall in non-residential construction and a small fall in dwelling

construction. Offsetting this would be support to growth from the government

budget announced in May.

     Still, the RBNZ's latest commentary is likely to suggest the upside risk to

inflation from higher capacity pressure due mainly to higher construction may

have faded, whereas the downside risk may have increased because residential

investment isn't likely to grow as strongly as expected in May.

     Some downside risk to the OCR also comes from the fall in the neutral rate

as that makes current monetary policy less stimulatory compared with previous

estimates. In a speech last month, RBNZ Assistant Governor John McDermott said

the neutral nominal OCR is currently estimated to be around 3.5%. This is at

least 80 basis points lower than the RBNZ's estimate of a 4.3% neutral rate in

2015.

     McDermott said the overall impact on the outlook for interest rates over

the RBNZ's projection horizon from this particular update on neutral rate will

be modest.

     Also, to look for in the policy statement is any change on its view on

non-tradable inflation, especially given subdued wage growth.

     In May, the RBNZ said the "current stance of monetary policy supports

strong GDP growth, such that non-tradables inflation gradually increases and

headline inflation settles around the target midpoint over the medium term."

     But a paper published by Philip Turner,a former Deputy Head of the Monetary

and Economic Department and a member of Senior Management of the Bank for

International Settlements, who reviewed the RBNZ's forecasting process

questioned why the RBNZ forecast non-tradable inflation to rise while labor

costs were not.

     It is likely the RBNZ has made a more detailed study of this relationship,

which could result in a subdued view on non-tradable inflation.

--MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@marketnews.com

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