This month the Reserve Bank of New Zealand (RBNZ) kept its Official Cash Rate (OCR) unchanged. It has been at 1.75% since September 2016. This latest review was notable for being the first for new governor Adrian Orr and a new Policy Targets Agreement (PTA).

In this note we look back at the recent OCR decision which provided further support to our view that the OCR will likely remain unchanged well into 2019.

We also discuss the changes to the PTA and their potential implications for monetary policy. Our conclusion is they may slightly increase the bar for OCR hikes.

If correct these would provide support for shorter dated NZ Dollar bonds. Support for longer dated NZ Dollar bonds would be less, given the higher offshore influence where yields have been rising. That said, if New Zealand monetary policy remains on hold it may extend the outperformance of NZ Dollar bonds versus their offshore peers.

The OCR is now likely on hold well into next year

When leaving the OCR at 1.75% the RBNZ updated its forward guidance. The new governor was very direct, simply stating “the direction of our next move is equally balanced, up or down” and that “only time and events will tell.” This left little need to look for subtle inferences to understand the bank’s message.

The bank noted a strong economic backdrop but acknowledged below target Consumer Price Index (CPI) inflation. It does expect a potential combination of increasing offshore inflation and ongoing domestic economic activity to lift CPI inflation gradually to its 2% target. How gradual? Its updated inflation forecasts suggest only in the second half of 2020. It was therefore not surprising to see its central forecast is for the OCR to remain unchanged at 1.75% though to second half of 2019.

The RBNZ underlined this forecast by reiterating its March statement. It expects the OCR to be at “this expansionary level for a considerable period of time”. In the context of its new PTA inflation and employment objectives, it added that is “the best contribution [it] can make, at this moment, to maximising sustainable employment and maintaining low and stable inflation”.

A new Policy Targets Agreement in advance of the introduction of a Monetary Policy Committee

In respect of monetary policy, the RBNZ is essentially independent. The PTA frames the government’s expectations from the bank.

The main change in the new PTA is the additional requirement for monetary policy to support “maximum sustainable employment”. Its inflation targeting objective, annual CPI inflation between 1% and 3% with a focus near 2%, was essentially unchanged. This new dual objective brings the RBNZ into line with the likes of the US and Australia.

One of the challenges for the RBNZ is that maximum sustainable employment is hard to quantify, lacking an identifiable numerical target. The RBNZ acknowledged as much, outlining its understanding will evolve through further work.

Some suggest the change will have limited policy impact, given employment already formed part of policy decisions. We believe the likelihood is that it underpins a predisposition for looser policy. Such a view is supported by the PTA requirement to explain policy support for the employment objective.

The proposed legislation to introduce a committee for monetary policy decisions may exacerbate this. Currently the governor has sole policy decision authority, albeit the RBNZ has operated an internal committee. The monetary policy committee may include three external committee members, in addition to four RBNZ members. With published minutes, and voting details to be released, that may increase the bar to tighten policy.