10 things of note from the Reserve Bank's September MPS

The Reserve Bank of New Zealand published its September quarter Monetary Policy Statement (MPS) and held its regular post-statement news conference on Thursday. Here's the ten things of note from the statement, the conference and the reaction. The bottom line is the OCR could now be on hold until mid 2015.

1. More Dovish - The Reserve Bank held the Official Cash Rate at 3.5% as expected, ending a sequence of four consecutive 25 basis point hikes since March. But it surprised a few economists and some in the markets by lowering its forecast track for the 90 day bill rate by around 50 basis points. It forecast the 90 day bill rate would rise to 4.8% by June 2017 from 3.7% now, implying another 100 basis points of rate hikes spread mostly over 2015 and 2016. In its September MPS its 90 day bill forecast rose to 5.3% by June 2017.

Westpac changed its view on the next OCR hike to June 2015 from January and ANZ said the next OCR hike could be delayed until June if the New Zealand dollar does not fall as expected.

2. A goldilocks moment - The biggest surprise came in the mix of growth, migration, house prices and inflation that allowed the Reserve Bank to lower the forecast track. Normally a lower forecast rate track would be produced after a slowdown in economic growth and a reduction in the sort of factors that drive inflation, such as net migration. But this MPS included a forecast of stronger GDP growth through 2015 and higher net migration, but lower inflation.

3. Does not compute? - The Reserve Bank said its initial rate hikes and the high LVR speed limit in October were having the desired effect of slowing demand growth and keeping inflationary expectations anchored. National house price inflation at 6% was weaker than the current mix of interest rates and net migration would normally suggest, the bank said. It said non-tradable inflation appeared slower than would normally be the case and cited growth in productive capacity because of net migration and stronger business investment. Essentially, the economy didn't produce as much inflation as the Reserve Bank expected from the mix of factors heating up the economy.

4. Migration the key - But the biggest surprise was the Reserve Bank's change of heart around the inflationary impact of a surge in net migration to 42,800 by the end of the year, well above its June MPS central forecast peak of 37,000. Back in June it included a scenario where net migration rose to a peak of 45,200, which it projected would increase house price inflation by around 4 percentage points and force interest rates around 50 basis points higher than the central projection to over 5.8%.

But this time the Reserve Bank said the composition of the migration could explain the smaller than expected boost to housing, with a lot more working students and fewer young New Zealanders leaving. "These groups may demand less housing than permanent arrivals," the bank said. The key section in the MPS is the first column on page four.

5. Wage suppression - The bank also noted the higher net migration, particularly of students who were given permission to work more in October, is helping to keep wage inflation relatively subdued, including in Canterbury. "Net immigration has also helped to alleviate wage inflation pressures in Canterbury and the construction sector more widely," it said.

6. But still wary - However, the bank is not completely convinced that the inflationary pressures from the net migration surge might be as benign as it suggests in this MPS. It said it remained on alert for signs that the higher net migration would pump up house prices, and also for signs that low international interest rates could feed through into low fixed mortgage rates and boost demand.

7. Jawbone exercised - Governor Graeme Wheeler used exactly the same language to warn currency markets that the New Zealand dollar was "unjustifiably and unsustainably high." "We expect a further significant depreciation, which should be reinforced as monetary policy in the US begins to normalise," Wheeler said. However, he declined to answer questions about intervention. The New Zealand dollar fell around half a cent to 81.8 USc after the statement and wholesale interest rates fell a few basis points.

8. Kicking for touch - With nine days to go until the election, Wheeler gave his best impression of Dan Carter kicking for the 22 from behind the posts on questions anywhere remotely near political matters. The bank made no mention of fiscal policy in the MPS and Wheeler flat out declined to answer questions about the marginally stimulatory impact of the Budget and the counter-productive impact on the bank's high LVR policy of National's doubling of first home buyer subsidies. Proposals for monetary policy reform from Labour, the Greens and New Zealand First were right off the agenda.

9. Shifting to neutral - The bank indicated that it wanted to shift the OCR towards neutral after this current extended 'pause'. It said the neutral level for the OCR was at 4.5%, but Wheeler agreed in the news conference that this 'neutral' level could fall if there were further signs of an increase in productive capacity and the inflationary pressures fail to flow through as expected.

The open question after this MPS is whether the Reserve Bank's inflation forecasting is accurately capturing any structural shifts in the global and local economy that appear to be dampening inflation, and in Europe in particular, even creating deflation. The MPS forecasts annual inflation will have been below the 2% target point for 19 quarters or almost five years. At some point this level of inflation consistently below 2% will raise questions about whether the Reserve Bank is running monetary policy too tight, which no doubt explains why the Reserve Bank has decided to 'pause' for an extended period.

10. Eurokiwi and Kauri Tsunami? - The most interesting chart in the MPS for exporters and importers wondering why the New Zealand dollar remains so strong was figure 3.4 on page 9 showing a recent surge in the issuance of Eurokiwi and Kauri bonds.

These are New Zealand dollar bonds issued by European and multi-national financial institutions, which are designed to take advantage of New Zealand's relatively higher interest rates to issue bonds to yield-hungry investors. Issuance has doubled to an average of NZ$1.3 billion per month in the first nine months of 2014. "To the extent that overseas investors have purchased these bonds, this has added upward pressure to the New Zealand dollar. In one day in June the International Bank for Reconstruction & Development raised NZ$800 million in the biggest Kauri issue ever, while Kommunalbanken AS also sold NZ$100 million of Kauri bonds, Bloomberg reported .