REPEAT: MNI INSIGHT: Weakening NZD-Infla Link Worries RBNZ

Repeats Story Initially Transmitted at 22:10 GMT May 23/18:10 EST May 23

--RBNZ No Longer Confident Lower NZD Will Boost Tradables CPI

By Sophia Rodrigues

     SYDNEY (MNI) - The Reserve Bank of New Zealand is doing some hard thinking

on the strength of any pass-through from exchange rate depreciation to

inflation, with the recent debate in the UK a reminder to small open economies

like New Zealand to keep the issue in review, MNI understands.

     This is a reason why the RBNZ's latest Monetary Policy Statement didn't

have much discussion on the New Zealand dollar's depreciation. Significantly,

there was no discussion of a scenario where the trade-weighted exchange rate

could depreciate because of higher global inflation and faster tightening in

global monetary policy, which could lead to higher import prices, thus requiring

a rise in the Official cash rate.

     In fact, throughout the entire MPS, the RBNZ appeared to have downplayed

the depreciation of the New Zealand dollar and the possibility of further

declines.

     The RBNZ merely said that it assumes the NZD trade-weighted index (TWI)

will depreciate very gradually over the projection. "As imports become more

expensive in New Zealand dollar terms, this adds slightly to tradables inflation

over the projection."

     --OCR CUT STILL POSSIBLE 

     On the other hand, the RBNZ focused on a scenario where the OCR could be

cut even as the exchange rate depreciates. This is one of the two risk scenarios

discussed in the May MPS, with the other being one where OCR could be raised if

price-setting behaviour by businesses becomes more forward-looking.

     The RBNZ said if global financial conditions were to tighten abruptly, it

would reduce world demand and lower the price of New Zealand's exports. This

could push up long-term interest rates and lead to higher funding costs for New

Zealand banks and, ergo, higher mortgage rates. 

     "While the New Zealand dollar TWI would depreciate, the increase in

mortgage rates and lower export prices would dampen consumption and business

investment. In this scenario, the Bank would need to lower the OCR to support

the economy and meet its inflation and employment objectives," the RBNZ said.

     --LESSONS FROM BOE

     The RBNZ is taking lessons from developments in the UK, where the Bank of

England recently said that the impact of the past depreciation of sterling on

CPI inflation, while remaining significant, is likely to fade a little faster

than previously thought. 

     Specifically, the Bank of England has assessed that the pass-through of

lower sterling value to import prices has been less than it previously expected.

     --EVOLVING LANGUAGE ON NZD

     It's interesting to note how the RBNZ's language on the exchange rate has

evolved in the last nine months.

     Until August last year, the central bank said a lower New Zealand dollar is

needed to increase tradables inflation and help deliver more balanced growth. By

November, the exchange rate had depreciated and the RBNZ said if the decline

sustains, it would increase tradables inflation and promote more balanced

growth.

     In February, the RBNZ didn't make any direct mention of the exchange rate

but said that the fall in the second half of 2017 and the rise in oil prices

would support tradables inflation.

     "The TWI remains lower than the level observed in mid-2017 and is expected

to support tradables inflation in 2018," the RBNZ said.

     Until then, the RBNZ was fairly confident that a lower exchange rate would

boost tradable inflation, and help inflation progressing towards the target

mid-point.

     However, the RBNZ's hopes were dashed in the Q1 consumer price index data,

which showed tradable inflation fell 0.4% y/y compared with their forecast for a

flat outcome. The data reminded the RBNZ that the exchange rate-inflation

relationship is weakening.

     That is why despite a lower starting point for the NZD TWI and a lower

forecast path in the May MPS compared with February, the RBNZ lowered the

forecast for tradable inflation instead of raising it.

     For Q2, the RBNZ is forecasting tradable inflation to rise 0.4% y/y versus

0.9% forecast in February. For Q3 and Q4 the RBNZ is forecasting 0.8% and 0.5%

rise versus 1.1% forecast in February for both Q3 and Q4.

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

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