Chief economist update: Betting on down rather than up?

"...the next move in the OCR could be up or down".

This was a fair enough hedged bet from the Reserve Bank of New Zealand (RBNZ) - more like the oft-repeated statements from other central banks saying "the risks are evenly balanced" - but Governor Adrian Orr's clarification that the current official cash rate (OCR) of 1.75 would remain "at this level through 2019 and into 2020" sparked a sell-off in the New Zealand dollar.

The NZ dollar fell 1.8% to US$0.6623 after the RBNZ's announcement from US$0.6743 the day prior. It's fallen some more in early trade, down to US$0.6604 - the lowest in more than two years and 7.1% lower compared to the US$0.7112 it fetched at the start of 2018.

The $NZ's drop suggests that the currency markets are betting that the next move in the OCR could be down rather than up.  This is because as printed in the August Monetary Policy Statement: "The decline in GDP growth over the past year suggests momentum in the economy may have eased."

Factset data shows that New Zealand's annual GDP growth rate has slowed from 4.8% in the March 2016 quarter to just 2.9%% in the same quarter of this year. The slowing trend in the country's economic growth could be starting to impact the labour market. The RBNZ predicts GDP growth of 2.7% this year and 2.6% in 2019 before accelerating to 3.4% in 2020.

While the unemployment rate remains low, the tick up to 4.5% in the June quarter from the nine-month low of 4.4% in the previous quarter ended five straight quarters of falling jobless rate. The sharp and sequential erosion in business confidence since January this year (-19 reading) to a nine month low -44.9 in July suggests continued upward movement in the unemployment rate.

The slowing trend in economic growth, erosion in business confidence and potential for higher unemployment do not augur well for inflation.

Latest stat on New Zealand's consumer prices reveal that the annual rate of headline inflation picked up speed to 1.5% in the June quarter from 1.1% in the previous quarter with the core inflation measure accelerating to 1.1% from 0.9% in the March quarter. The August Monetary Policy Statement forecasts the headline CPI inflation rate to ease to 1.4% in the September quarter of this year and won't reach the midpoint of its 1%-3% target before the March quarter of 2021.

In away the New Zealand dollar's depreciation would help support the country's central bank towards reversing the trend slowdown in the economy while at the same time putting upward pressure on inflation.

This of course provided that the recent decline into a precipitous slide in the currency that could another set of problem for the RBNZ - i.e. it might have to raise interest rates to stop funds outflow and/or an unwanted surge in inflation.

The New Zealand dollar is now trading at US$0.6595, down another 0.14% from when I started this piece.

Ben Ong is the Director of Economics and Investments at Rainmaker Group. He previously worked as a fund manager, economist, asset allocation strategist, portfolio analyst and stock market analyst. Check out his economics analysis here.

Read more: RBNZGDPAugust Monetary Policy StatementBettingCPIFactsetGovernor Adrian OrrReserve Bank of New Zealand
Link to something xsgEFO43