RBNZ pauses on rates but warns on currency

Most expect the Reserve Bank will wait until its December 11 Monetary Policy Statement at the earliest before resuming its hiking cycle. The bank forecast in June it would increase the Official Cash Rate by a further 125 basis points through late 2014 and calendar 2015. 

According to ANZ Chief Economist Cameron Bagrie, this latest decision is more dovish than previous ones. He now expects a pause until March next year. 

"This is a marked departure from the ‘business as usual’ tone of the last few policy assessments," Bagrie said. 

"The RBNZ is more comfortable with where the economy is headed on the inflation front, the risk profile is more nuanced - a bit more downside has been opened up - and the currency is still problematic. So in the words of David Lange, we’re stopping for a cup of tea." 

Then Labour Prime Minister David Lange used the phrase to 'have a cup of tea' to argue in 1988 for a pause to disruptive and rapid economic reforms. 

Accompanying the latest decisions, Reserve Bank governor Graeme Wheeler said "encouragingly, the economy appears to be adjusting to the monetary policy tightening that has taken place since the start of the year". 

The Reserve Bank also dropped the business as usual approach to the currency, which has been stubbornly higher than the bank has forecast for all of this year, with Wheeler noting how the New Zealand dollar had not fallen in line with commodity prices. 

"With the exchange rate yet to adjust to weakening commodity prices, the level of the New Zealand dollar is unjustified and unsustainable and there is potential for a significant fall," he said. 

Potential soon became reality. The New Zealand dollar dropped more than a cent at the end of the week to well under US86c. 

The comments also fired up speculation the Reserve Bank could intervene directly in currency markets to sell the New Zealand dollar down. 

The decision by the central bank to take a break on Thursday came after five months of being out on its own among the developed world's central banks in tightening monetary policy. It signaled a pause in its hiking cycle some now expect to last until March after an easing of business and consumer confidence and a slowdown in a house price inflation that had been running at over 10 per cent. 

It also tried to reduce the pain for exporters of a currency out of line with falling commodity prices by jawboning the currency lower in a way that some interpreted as suggesting intervention was possible. 

The central bank closed off the cycle by hitching up the OCR 25 basis points to 3.5 per cent, extending its tightening to 100 basis points since March. This at a time when central banks in economies producing two thirds of global output have kept their interest rates at almost 0 per cent. 

But the Reserve Bank also signaled "a period of assessment before interest rates adjust further towards a more-neutral level". 

Of New Zealand's trading partners, only Australia has an official interest rate that is anywhere near New Zealand's, and its cash rate has been on hold at 2.5 per cent for almost a year with little current sign of movement. 

That widening gap in interest rates has made the New Zealand dollar increasingly attractive to yield-hungry investors. It has risen 7 per cent this year despite a 35 per cent fall in dairy and log prices, the core Kiwi commodities. Foreign investors have increased their holdings of New Zealand Government and corporate bonds by $NZ12.1 billion to $NZ51.6 billion in the last two years as the yield gap has widened. 

The rise in the New Zealand dollar to just below its post-float high of US88.4c in the weeks before this decision was a factor in the decision to signal a pause, along with only moderate wage inflation and early signs the tightening is slowing an economy that had been growing at an annual rate of 4 per cent. 

Westpac Chief Economist Dominick Stephens said the Governor's comments were a direct warning that the bank may intervene to sell New Zealand dollar within days. 

"We interpret this choice of language as a direct warning of intervention," Stephens said. 

Other economists were less sure, saying intervention was less likely, although could not be ruled out. 

The Reserve Bank operates a "traffic light" system for deciding on whether to intervene. The currency must be at 'extreme' and 'unsustainable' levels, and the Reserve Bank must be able to intervene in a way that catches the market offguard at an 'opportune' moment. Any intervention must also not clash with the bank's monetary policy moves. 

The Reserve Bank's comments were seen as satisfying the extreme and unsustainable conditions, while the pause in the rate hike cycle is seen opening the door for intervention that did not clash with a tightening. 

"On the face of it, ‘unjustified’ opens the door to currency intervention," Bagrie said. 

"We’re not convinced the trigger will be pulled. It's more likely we’ll see covert and passive action as opposed to open intervention, but we’re on notice."