Mark Lister, 16 May 2018

The key message markets took from the Reserve Bank the other week was that the next move in the Official Cash Rate (OCR) won’t necessarily be up.

Reserve Bank forecasts still point to an increase in the OCR late next year, although a shift in the other direction isn’t out of the question. Governor Adrian Orr was very forthright in his comments that risks were finely balanced, and the door was open to a cut.

When questioned about what sort of conditions might need to exist for us to see a cut, he noted tightening financial conditions as a key risk. In market speak, that means the rising cost of money as global interest rates increase.

Interest rates are still very low across the world but they’re moving higher, led by the US. The two-year US Treasury yield is the highest in nearly ten years, and we’ll soon see the cash rate over there ahead of our OCR for the first time since 2000.

Those rising interest rates have given the US dollar a bit of support. A weak US dollar provides ample liquidity to the rest of the world and as that reverses, a rising greenback is adding to this tightening in global monetary conditions.

Our Reserve Bank is watching all these trends closely. If higher borrowing costs filter through to New Zealand and begin to dent our economic outlook, that’s when the Reserve Bank might consider cutting.

Despite our OCR being at a historic low, we have more to work with than many other countries. Few stable, developed countries have a cash rate as high as 1.75 per cent at present, which gives us another option if we need it.

For the record, I’ll be surprised if our OCR goes lower anytime soon. However, we could see some other interesting developments, most notably for the currency.

With our central even more firmly on the sidelines, and others around the world either actively raising rates or at least talking about less stimulus, the NZ dollar looks set to drift lower.

It has declined against all major trading partners since the Reserve Bank statement, falling to almost a six-month low on a trade-weighted basis. The currency fell to US$0.69 for the first time since December, seven per cent below the $0.74 where it was trading three months ago.

Exporters will be more than happy with this and it will provide an added boost to many sectors, including tourism, agriculture and technology. However, consumers will experience increasing cost pressures, particularly for fuel.

Oil prices have climbed steadily this year, with US crude hitting the highest levels since 2014. When combined with a falling NZ dollar, this is a recipe for local fuel prices rising further. Pump prices have already moved to a four-year high, close to 20 per cent above where they were in the middle of last year.

Ironically, this dynamic adds to inflationary pressures. If the cautionary stance from our Reserve Bank sees the currency slip further, prices will move higher until inflation reaches a level where a potential cut in the OCR makes much less sense.

That’s when we’ll find out what this new Policy Targets Agreement really means.

This article was also published in the New Zealand Herald under the title All eyes on rising global rates and the impact on NZ's OCR on 17 May 2018