RBNZ Retained Monetary Stance, Raised Growth Outlook But Remained Cautious

As we and the market expected, the RBNZ left the OCR unchanged at 2.5% and reiterated the stance to 'removing policy stimulus around the middle of 2010'. The quarterly MPS also revealed modest upgrades in 2011 GDP growth and inflation. However, potential GDP growth in 2010 has been revised downward. We retain our view that the RBNZ will begin tightening in June with a hike of +25 bps.

RBNZ's monetary decision and tone to economic outlook remained similar to previous meetings. The central bank stated domestic economy 'grew at a stronger pace in the December and March quarters than in the prior two quarters'. These are 'broadly expected and growth is predicted to pick-up further through 2010'. However, the RBNZ remained 'cautious' in the economic outlook. 'Policy stimulus and improved consumer confidence have seen a pick-up in household spending. That said, households are still cautious with house sales and credit growth remaining subdued. Business spending is weak despite much improved confidence'. We believe the central bank needs to see sustainable domestic growth before implementing tightening.

For global trading partners, activities have recovered 'a little faster than expected' with strongest growth momentum from China, Australia, and emerging Asia. That said, the RBNZ remains 'conscious of the small risk of the world economy turning out much weaker than expected. It is also mindful of the somewhat more likely scenario where the world economy turns out moderately stronger than we predict'.

We are surprised to see the RBNZ upgrading its inflation forecasts for 2010-2012 given the higher-than-expected unemployment data in 4Q09. However, the central bank now anticipates employment to increase by +2.5% in 1Q11, thereby raising the labor costs and inflation. Moreover, the upgrade in inflation outlooks is also driven by pending ACC levy increases and the amended Emissions Trading Scheme. Despite the increase, the RBNZ added annual CPI inflation is expected to track within the target range (1-3%) over the medium-term.

Another key issue mentioned in the statement is related to bank funding costs. 'Higher bank funding costs have reduced the level of stimulus that would normally be associated with any given level of the OCR. We expect these costs to persist over the projection reducing the extent of future increases in the OCR. Fiscal consolidation would also help reduce the work that monetary policy might otherwise need to do'. This may signal that the RBNZ may act more gradually as it has expected.

We are not going to change our view that the RBNZ will begin tightening in June with a hike of +25 bps for the moment but will gauge data releases in coming months to see the path of economic recovery. We believe employment, housing sales and credit growth are key data