Picks for the December RBNZ meeting
Posted November 27, 2008on:
I’m going with a 75 basis point cut on December 4. Now no-one might agree with this, iPredicit certainly doesn’t (putting the probability at 3% when I looked), but there are reasons:
Update: I brought some 75 shares in iPredict after posting this post – because agnitio told me to.
- Petrol price collapse (which might be seen as inflationary),
- Mortgage rate collapse,
- Wholesale cost of credit is falling.
In fact, I would go for a 50 if it wasn’t for the fact that 2 year ahead inflation expectations tumbled to 2.7% in the December quarter! Let me sort of sketch out why.
When the RBNZ is setting interest rates, we need to think about where their “neutral rate” is, this is the rate where monetary policy is neither aiding or hindering growth . A rough version of the neutral rate could be: Neutral = pop growth + time preference (which is a function of expected per capita growth) + inflation.
As population growth is kicking around 1%, natural per capital growth slapping around 2%, and underlying underlying inflation is at 3.5%, the neutral nominal interest rate is 6.5% – hey that is where we are now! Of course there is currently a risk premium which is knocking up market interest rates – implying that neutral is closer to 6.0%.
Now I might be overplaying inflation – but I am probably underplaying “time preference” anyways, so things should all equal out 😉
With fundamental inflation pressures still strong (at least according to the LCI) they may not want to go too far under neutral. A 75 basis point cut (which would take the OCR to 5.75%) would put us just under neutral, but would give the Bank scope to keep an eye on how data unfolds before loosening further. Furthermore, the Bank can commit to cutting further in the future – say to 5%, thereby loosening current monetary policy without unnecessarily throwing around the official cash rate given uncertainty about future outcomes.
The market expects 125 points of cuts. Economists expect 100 (by median) with a few picking 150. Ipredicit seems to be poking towards “above 100” (the other contract, the 100 contract, and the 50 contract) I’m sitting on 75.
I can see these higher outcomes occurring (specifically 100 – Update given that market expectations are for 125 and wage growth expectations are falling), but given my view of neutral and the existence of elevated “uncertainty” I just can’t sell a bigger cut than 75 to myself. Sure things are bad; commodity prices are falling, world activity is declining, and we have been sitting in a recession for nine months – but a 75 basis point cut in the face of loosening wholesale markets is still one hell of a softening in monetary policy!
What do you guys think?
Update again: It is a few days after I have risen this, and now economists are picking 150bp. Did anything unexpected actually happen?
Update: They did 150 😛 Global growth is just too important – but then, why isn’t their terms of trade track declining more?