MNI INSIGHT: RBNZ Sees Fewer But More Probable Downside Risks

By Sophia Rodrigues

     SYDNEY (MNI) - Despite pointing to a greater number of upside risks than

downside, the Reserve Bank of New Zealand sees the risks to hike or cut in the

official cash rate as equally balanced because of higher probability of the

fewer downside risks coming to pass, MNI understands.

     At the OCR decision earlier Thursday, the RBNZ left the rate unchanged at

1.75% but surprised by saying upfront that the risks for the next move to be up

or down are "equally balanced," whilst pledging to keep the rate unchanged for a

considerable period of time.

     At the press conference following the decision, Governor Adrian Orr, in the

lead seat for the first time, reiterated that the door is open to both a rate

cut and a rate rise, and the risks are relatively balanced.

     Such guidance contrasts with the risk assessment provided in a new table

included by the RBNZ in the Monetary Policy Statement, which showed a lot of its

key judgements carrying upside risk, more than the ones that carry downside

risk.

     The upside risks relate to judgements about trading partner inflation, oil

prices, household consumption, house price inflation, net immigration, labor

force participation and impact of minimum wage growth on inflation. However the

individual probability of this occurring is expected to be low.

     The fewer downside risks related to judgements about labor force

participation, investment growth and output gap, but the individual probability

of occurrence is higher.

--OUTPUT GAP KEY

     Ultimately, the key determining factor for a rate cut would be how the

output gap performs relative to the RBNZ's forecast.

     In the statement, the RBNZ forecasts the output gap will reach 0.9% of

potential output by 2021 from around zero currently.

     Based on the risk assessments, for the output gap to fall short of

expectation, investment growth would have to undershoot the RBNZ's forecast

and/or labor force participation has to increase versus the forecast for it to

remain around 70.8%.

     Investment growth could falter in a scenario where global economic activity

would be adversely affected if financial conditions tighten abruptly. 

     This would reduce global demand and lower the price of New Zealand's

exports. Long-term interest rates would also increase, and ultimately result in

higher local mortgage rates and while the New Zealand's dollar trade-weighted

index would depreciate, the increase in mortgage rates and lower export prices

would dampen consumption and business investment. 

     The other downside risk to investment is if capacity constraints in the

construction sector continue to bond and KiwiBuild crowds out private sector

investment.

     Labor force participation could increase if a strong labor market attracts

more workers. This can impact the maximum sustainable employment level, and

would require still higher employment to maintain the output gap.

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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