Interest rates — US lifts, NZ holds

The Reserve Bank took a “steady as she goes” approach to monetary policy, keeping its official cash rate (OCR) at the historical low point of 1.75 per cent.

In yesterday’s release, the Reserve Bank said it expected to keep the OCR at this level through 2019 and into 2020. The next move could be up or down.

The bank’s move was in stark contrast to the US Federal Reserve’s decision to lift its federal funds rate to a range of 2.0 to 2.25 per cent. The differing stances of the two central banks has put another nail in the coffin of New Zealand dollar’s reputation as a “carry” currency, when it once offered rates of interest that were far more attractive relative to those available in other countries.

The Reserve Bank’s statement follows data from Stats NZ this month that showed the economy grew by 1.0 per cent in the June quarter, higher than market expectations of 0.8 per cent and double the central bank’s forecast.

“While GDP growth in the June quarter was stronger than we had anticipated, downside risks to the growth outlook remain,” Reserve Bank Governor Adrian Orr said in a statement.

Phil Borkin, senior macro strategist at ANZ, said the Reserve Bank’s stance would limit any gains in the kiwi.

Interest rate differentials — the different interest rates that prevail in various countries — are an important driver for the foreign exchange markets.

“They work on expectations of those interest rate differentials and, at the moment, markets have priced in a 30 per cent chance of a cut by the Reserve Bank, and are priced for more hikes by the Fed,” Borkin said. “The issue is, is there going to be something that changes that situation? And for the near term, I don’t think that’s the case,” he said.

ASB chief economist Nick Tuffley said he expected the bank to keep rates on hold and to lift the OCR early in 2020.

“However, the risks through to mid-2019 are tilted to a lower OCR due to low levels of business confidence,” he said in a commentary. “Although the Reserve Bank will have been pleasantly surprised by the strength of second-quarter GDP, continued soggy business confidence will keep it wary about the growth performance for the rest of 2018 — particularly the tail end of the year,” Tuffley said.

Yesterday’s central bank news means the kiwi no longer rated as a “carry” currency, Mark Brooks, head of income at NZ Funds, said.

“New Zealand interest rates are low and, while the economy is robust, inflation remains subdued and it is not obviously overheating,” Brooks said.

NZ Funds sees the impact of higher US interest rates coming through the currency rather than domestic interest rates. It expects the kiwi will struggle against US dollar over the next year.