RBNZ Refrains From Reversing Insurance Cut

Given the dramatic global economic downturn since the July RBNZ meeting, we now believe that the central bank will remain on hold in September and probably in October. While there is yet little evidence showing New Zealand's outlook has been hurt by the rising uncertainty in US economy and European debt crisis, such a small and open economy is vulnerable to international shocks. We believe it's prudent for the RBNZ to leave the OCR unchanged at 2.5% and to deliver a less hawkish statement than the previous one.

Global economic developments have deteriorated sharply in August and early September. Signs of a US recession have intensified with the Fed explicitly stating to keep rates low at least until mid-2013 and President Obama announcing new measures to stimulate growth. Speculations of QE3 have heightened. Sovereign debt crisis in the Eurozone remained under the spotlight. ECB's reactivation of the SMP and resignation of an Executive Board member evidenced the division among policymakers and hinted growing difficulties in policy formulation in the future. Inflation outlook appeared to have moderated as commodity prices fell. However, central bankers will remain cautious on the issue as a new round of quantitative easing will inevitably spark a new round of inflationary pressures.

Economic indicators released during the intermeeting period were limited but they did show a solid and positive trend in domestic growth. Retail sales excluding auto climbed +1.4% q/q in 2Q11 after rising +1.3% in the previous quarter. Rugby World Cup, expecting to bring 85K of tourists to the country, is the next stimulus to retail sales in coming months. Improving consumer confidence has been driven by growing momentum in the job market. Unemployment rate stayed at 6.5% in 2Q11, unchanged from 1Q11 but eased from 6.7% in 4Q10. On annual basis, the number of unemployed fell -0.4%. During the quarter, only 1K of payrolls were added but encouragingly the participating rate stayed firm at around 68%, indicating that labors remained optimistic towards the employment outlook.

Inflation expectations moderated. A RBNZ surveyed showed that inflation expectations in a year eased to +2.94% from +3.12% a quarter ago. Inflation expectations in 2 years also eased to +2.86% from +3.00% in the previous survey. The outcomes suggested that households and businesses are not overly worried about price pressure although headline inflation has been held at elevated levels due to temporary factors such as GST.

The post meeting statement will show a setback from the previous meeting. In July, the RBNZ stated that 'provided current global financial risks recede and the economy continues to recover, the Bank sees little need for the March 2011 'insurance' cut to remain in place much longer'. As the condition mentioned in the first part has not materialized, it's unlikely for the central bank to reverse the cut in the meeting. Honestly, the timing for the rate hike is getting more uncertain as it's highly dependent on how the global economy evolves.