NEWS / Foreign Exchange

A thin veneer

The Reserve Bank??™s OCR review came and went with barely a flutter in financial markets.

As expected, the OCR remained on hold at 8.25% last Thursday. In the first and last sentences of the statement, the Bank basically said it was officially on hold. But the bits in between were a litany of woes about inflation. The tight labour market, strong commodity prices, and core inflationary pressures were mentioned up front. The RBNZ pointed to inflation risks from food and carbon prices ??“ we interpret that as meaning their headline inflation forecast now peaks above 3% just as ours does. The RBNZ gave an extraordinary rebuttal to the Minister of Finance, bluntly stating that ???fiscal policy is contributing to inflationary pressure???. And the inflation downsides were brushed over ??“ the RBNZ characterised the housing market as only ???moderating???, and they marked the NZD as only ???relatively high???.

We share the RBNZ??™s nervousness about inflation. There are huge upside risks from higher food prices, energy, wages, rents and carbon costs. Consumer spending is already running hot, and we expect much more next year when the tidal wave of dairy cash hits. The notion that ???the farmers won??™t spend it??? is being shown up as rubbish ??“ there has already been a veritable boom in rural retail trade. Judging by recent electronic transaction statistics and the irrepressible optimism in consumer sentiment surveys, spending will accelerate further in the months ahead. Dairy is likely to be just the vanguard in a parade of higher food prices. As one of the world??™s biggest food exporters, New Zealand will surely benefit. And there will surely be inflationary consequences.

That said, the RBNZ is wisely on hold for the moment given the global uncertainties. They won??™t move rates in December. They currently hope to muddle through next year without having to raise rates, but we think their hope will be in vain. The Governor??™s hand will be forced to hike the OCR twice more next year, starting in March.