Benign Inflation And Subdued Household Spending Likely To Slow RBNZ's Tightening Path

Although New Zealand's economy has been growing for 4 quarters up to 1Q10 and another positive reading will likely be seen in 2Q10, we think the pace of expansion has moderated. Meanwhile, recent data such as retail sales, housing activities and consumer price index have indicated domestic spending has been rising only gradually. Externally, economic activities in the US and China have shown signs of slowdown while sovereign crisis in the Eurozone is yet to be resolved. We expect the RBNZ to be cautious in tightening its monetary policies.

New Zealand's economy grew +0.6% q/q in 1Q10, following an upwardly revised +0.9% expnsion in 4Q09. However, contribution from household spending remained relatively subdued despite strong recovery in the job market. This suggested that consumers were still cautious in the growth outlook.

The situation of benign domestic spending persisted in the second quarter. In May, retail sales climbed +0.4% m/m, after a -0.3% contraction in April. Excluding auto, the reading declined -0.2% in May following a -0.1% drop a month ago. Despite robust confidence data and sharp decline in unemployment, consumers remained cautious in spending money and retail sales have been fluctuating between gains and losses over the past few months.

House sales fell for a third month in June and the time to sell a property increased. According to the Real Estate Institute, seasonally adjusted house sales plunged -5.3% m/m and -24% y/y in June while the number of days to sell rose to 44 days from 43. Although house prices edged higher during the month, the overall trend remains down. Mortgage rates have been rising lately as the RBNZ raised the policy rate at the previous meeting and European woes increase funding costs in banks. If the situation in the Eurozone persists and the central bank tightens further, the mortgage will continue to increase and hurt the property market further.

Headline CPI eased to +0.3% q/q in 2Q10 from +0.4% in the prior quarter. The reading came in weaker than consensus estimate of +0.4% and RBNZ's forecast of +0.5%. On annual basis, inflation decelerated to 1.8% from 2% in 1Q10. The biggest contributor to the price increase was alcohol and tobacco (+8.7%) as driven by the excise levy. Non-tradable inflation of +2.2% was below historical average of +3%. Although we expect price level to surge later in the year because of the GST and emissions trading scheme, the set of weaker-than-expected data in the second quarter may allow the RBNZ to raise interest rates only gradually.

In June, the RBNZ hiked the OCR by +25 bpd to 2.75%. The central bank also stated 'further removal of stimulus will be reviewed in light of economic and financial market developments'. We expect the RBNZ will raise the OCR by another +25 bps at July's meeting, followed by 2 more hikes, each by +25 bps, later this year. After that, the central bank will likely pause for some time so as to gauge the impacts of tightening. The RBNZ may pause earlier than we expect, depending on how the domestic and global economies develop.