NZD: Why You Should Consider Positioning For A Rate Cut

Opinion remains divided on whether the Reserve Bank of New Zealand will seek to cut the Official Cash Rate (OCR) this week. In a conference the other day, I listened to impassioned pleas as to whether a rate cut should be attempted now or September. I even heard one speaker suggesting that the specific tone of RBNZ Governor Wheeler’s voice could be analysed for stress which would provide indications of his bias. Regardless, today’s rate decision is a critical one and there is some definite evidence that adds to an argument for a rate cut.

1. Auckland House Inflation
The property market within Auckland has been incredibly buoyant for some time leading to annual gains of upwards of 17%. Much of the gains have been due to a lack of supply within the super city whilst increasing immigration numbers have placed the property stock under additional pressure. This supply imbalance, coupled with no taxation of capital gains, has created rampant price inflation.

The issue of property prices has become substantial enough that the RBNZ recently ran stress tests across all of the large banks. The stress tests modelled the effect of a 30% housing price collapse on capital requirements, and the results were stark. Banks came within 1% of their prudential requirements giving rise to the view that the property market could pose a risk to the wider financial system.

Subsequently, the RBNZ moved to introduce a set of speed limits, which created a new loan category for property investors, and required banks to significantly increase the required LVR amounts. This has been a marked restriction to property speculators seemingly isolating them from the Auckland market.

The LVR limits tend to firm the case for a rate cut in June as they effectively allow the RBNZ to isolate the Auckland market from the benefit of a looser monetary policy. This way the central bank can cut rates without the fear of exacerbating the current speculative property bubble.

2. Global Dairy Price Declines
The global dairy price index is an important barometer for the New Zealand economy as dairy represents around 30% of all export activity. In fact, Fonterra represents the world’s largest dairy producer as well as New Zealand’s largest company. Global dairy prices have experienced 4 consecutive cuts since March and this has prompted Fonterra to significantly cut the expected dairy price that New Zealand producers are likely to receive. Overall, milk prices are down by approximately 40% since last year.

Falling dairy prices are not a good sign for New Zealand considering much of their GDP is inexorably tied to the agricultural trade. Simply put, GDP growth is likely to be subdued without a vibrant dairy export trade. Subsequently, the RBNZ would want to desperately avoid any further impediment to growth and might seek to stump up declining demand with some fresh stimulus.

Overall, timing a rate cut is incredibly difficult but the isolation of the Auckland property market to any cuts, as well as the weak global dairy trade, provides an adequate argument for a rate cut. The evidence indicates that theground-work has been done for a rate cut in June, and most economists seem to agree that stimulus is needed.

However, RBNZ Governor Wheeler has the canny ability to change market expectations, through his statements, without the need to follow up with action. Subsequently, watch out for any jaw-boning that may occur during the speech, driving the kiwi lower and leaving most economists unsatisfied.