MNI RBNZ WATCH: More Hikes Still Needed Despite Hold - Breman

The Reserve Bank of New Zealand’s Monetary Policy Committee voted four-three to leave the Official Cash Rate unchanged at 2.75% on Wednesday despite overwhelming market expectations of a hike, though Governor Anna Breman told reporters there was still broad agreement that further tightening will likely be needed.

“When we look very deeply at this number, 3.7% [y/y] is far too high, but it was actually lower than we expected,” Breman said, referring to Q3 annual inflation. Higher fuel prices had generated less indirect price pressure than anticipated, while inflation expectations remained well anchored and wage growth was below levels consistent with returning inflation to target, she said.

The two recent OCR increases would also take time to affect the economy, Breman noted, adding that the Bank still expected to raise rates at coming meetings.

Breman and committee members Carl Hansen, Prasanna Gai and Rebecca Williams voted to hold, while Chief Economist Paul Conway, Assistant Governor Karen Silk and committee member Hayley Gourley favoured a 25-basis-point increase. Markets had priced in a more than 90% chance of a 25-basis-point hike before the decision. (See MNI RBNZ WATCH: High Core Inflation To Drive Hike) 

The New Zealand dollar weakened about 1.4% against the U.S. dollar to 0.5674 following the decision, while overnight index swaps firmed about 11bp across meetings, with markets pricing in an 84% chance of a 25bp hike on Dec. 9.

Breman described the decision as difficult amid global volatility, but said the committee followed a robust process to assess the inflation and economic outlook. “Everyone is fully committed to bringing inflation back to target over the medium term,” she said, noting the Bank also wanted to avoid unnecessary instability in output. 

The RBNZ is monitoring the New Zealand dollar's weakness for its potential to lift imported inflation, although short-term exchange rate volatility generally had a limited effect on overall prices, she added. The Bank will focus on how exchange rate movements affect growth and inflation over the medium term, rather than reacting to short-term volatility, she added.

DECEMBER OUTLOOK

The MPC will closely monitor incoming inflation indicators, inflation expectations, labour market data and developments in the global economy before its Dec 9 meeting, with Breman highlighting partial inflation data, including the selected prices index (SPI), as important for assessing whether higher fuel costs were feeding through to other prices. 

Breman said the discussion at Wednesday's meeting suggested the OCR path could involve more tightening than the Bank projected in September, although the outlook remains dependent on incoming data.

“Currently, our forecast from the OCR, and the last one we have is from September, is that it's likely to see further OCR increases, and the discussion has been at this meeting, well, it's likely to maybe be a bit more than what we said in September, but we will get more data, and then we have a full forecast in December and a new OCR [path],” she said.

MARKET PREPARATION

Breman pushed back against suggestions the Bank should have done more to prepare markets for the possibility of a pause, noting that Q3 inflation data were released during the MPC's communications blackout. 

But transparency remains important to helping markets understand the Bank's reaction function, she said, adding previous meeting records showed the committee had discussed a range of possible policy outcomes.

MNI BOJ WATCH: Board Likely To Hold, Examine Rate Hike Impact

The Bank of Japan Board will likely keep its policy rate unchanged at 1.25% this week as upside inflation risks have not strengthened further and officials scrutinise the impact of past rate hikes on financial conditions and the economy.

BOJ officials are monitoring corporate financing, banks’ lending attitudes and medium- to long-term inflation expectations through data due before the Dec 17-18 meeting, which markets see as the far more likely date for the Bank's next hike. 

September’s 25-basis-point increase to 1.25%, alongside economic uncertainty, has already affected smaller firms, according to the BOJ’s quarterly branch managers’ meeting, which also highlighted pressures on real-estate companies. (See MNI BOJ WATCH: Ueda Signals More Hikes, But Timing Unclear) Officials believe the cumulative effects of past hikes could emerge suddenly, dampening inflation and output, although they see little risk of a sharp downturn.

OUTLOOK UPDATES

Higher crude oil prices are likely to prompt the BOJ within its updated Outlook Report to be published alongside this week's decision to raise its inflation forecasts made in July for the current fiscal year and fiscal 2027 from 2.5% and 2.4%, although the revisions are expected to be small.

The Bank will also consider its assessment of underlying inflation, which is approaching its 2% target, and is expected to say that underlying CPI inflation is largely consistent with its goal.

However, the BOJ will emphasise that its ultimate objective is to stabilise underlying inflation at around 2% and that it stands ready to adjust monetary policy to prevent inflation from deviating from that level. (See MNI POLICY: BOJ Nearing Target To Forgo Victory Declaration)

Governor Kazuo Ueda said on Oct. 16 in Bangkok that he “cannot tolerate” underlying inflation rising further above 2%, signalling that the BOJ will continue to raise rates to adjust the degree of monetary accommodation.

CAPEX PLANS

Short-term interest rates remain negative in real terms, cushioning the effects of monetary tightening so far. However, bank officials are monitoring companies’ “hurdle rates,” the minimum rate of return they must earn on an investment to justify the risk and cost of capital and how this compares to funding costs.

Reports of postponed investment also require further analysis. The December Tankan survey should provide more information on firms’ financial positions and financial institutions’ lending attitudes. 

BOJ headquarter officials are asking regional branches to gather information on evolving business plans in real time. They believe direct discussions with smaller firms offer a faster way to gauge the effects of higher rates, as the impact on bank lending and capex takes time to emerge.

BANK COMMUNICATIONS

Officials are also considering how to communicate the policy outlook to temper market expectations of rate hikes every three months, which could trigger market-driven tightening. The BOJ is expected to maintain its assessment that risks to prices are tilted to the upside, while adjusting the wording to discourage market participants from pricing in quarterly rate hikes.

MNI INTERVIEW:German Firms See Risk In Tougher EU China Stance

The recent EU-China trade understanding reached in Beijing and the mid-October European Council summit will help maintain dialogue and cool trade tensions, but growing pressure on Brussels for tougher measures against China risks disrupting German companies' increasingly complex business ties with the country, a German industry official told MNI.

Oliver Oehms, executive director of the German Chamber of Commerce in China - North China, said that underlying structural challenges remained unresolved, despite the latest developments. (See MNI EM POLICY: EU Aims To Extend China Hybrids Deal To Chemicals)

At the mid-October European Council summit, which followed China’s agreement to cap hybrid vehicle exports and discuss a reduction to import tariffs, EU leaders outlined plans to continue dialogue while developing new instruments to address economic imbalances. However, this prompted Chinese officials to warn Brussels that it should not expect concessions through pressure or underestimate Beijing’s determination to defend its interests.

The practical significance of potential reductions in Chinese import tariffs on products including automotive components would depend on their implementation and whether they translated into meaningful improvements in market access and export volumes, he added. (See MNI EM INTERVIEW: China To Boost Imports To Balance Trade)

"German companies are advocating for a balanced and coordinated European approach," he said, noting that measures should address genuine market distortions while avoiding blanket tariffs or broadly framed restrictions.

The Chamber's upcoming Business Confidence Survey illustrated concern among German companies operating in China, with 80% expecting negative consequences to established businesses, supply chains and investment plans should tensions escalate, Oehms added.

"We therefore support, wherever needed, targeted, sector-specific instruments, alongside efforts to strengthen Europe's own competitiveness.” (See MNI INTERVIEW: EU Looks At Options To Boost Competitiveness)

Expectations were growing that Germany could support a firmer European trade position, including industry- or sector-specific tariffs, while stopping short of the strongest measures against China, he said.

CHINA OVERSEAS

Results from the chamber’s most recent business confidence survey showed 68% of members surveyed were doing business with Chinese companies expanding overseas, which would further complicate efforts to address the growing trade imbalance, Oehms added. 

Another recent study by the Chamber into how German firms were partnering with Chinese companies going abroad suggested a significant part of the margins generated by some members now comes from such business, as intense competition squeezes prices and profitability in the domestic market.

That makes bilateral trade figures an increasingly incomplete measure of the economic relationship, he argued, as suppliers participate in their Chinese customers' expansion into third markets. 

German companies in China also face diminishing opportunities to embed themselves in Chinese companies' international supply chains, Oehms warned. Their knowledge of international standards and standardised products and services currently makes them attractive partners for project developers expanding abroad.

“If we take a step back now, we will miss the train,” he said. “The Chinese companies will either catch up themselves or they will set their own standards, and then we might be excluded from future projects.”

The tensions are also playing out within companies, with China-based executives seeking to follow customers into overseas markets sometimes facing resistance from headquarters, which could include geographical limits on where they can pursue business, Oehms said.

If current trends continue, he expects German participation in Chinese companies' overseas expansion to gain importance over the next two or three years, though this trend too could eventually encounter resistance as emerging economies seek to protect and develop their own industries.

MNI INTERVIEW: Fed To Reassess Policy After Dec Hike- Bullard

Two rate increases for the Federal Reserve this year amount to a sensible mid-course correction, keeping policy modestly restrictive and putting downward pressure on inflation in 2027 and 2028 in case price pressures prove stickier than expected, former St. Louis Fed President James Bullard told MNI.

Markets have run ahead of the FOMC on near-term timing, and the committee will likely reassess the outlook in December with a new set of economic projections in hand, he said, adding he expects widespread agreement on a hold on rates this week. 

The FOMC “did not intend to move particularly rapidly,” and the September economic projections pointed to a quarterly pace, he said in an interview. "What they're doing is taking out some insurance to make sure that policy is modestly restrictive and that they'll put downward pressure on inflation in 2027 and into 2028."

The median dot for 2027 leaves the fed funds rate at a 4-4.25% range. "I interpret that as watchful waiting, where the committee reserves the right to reassess -- and they will have other SEPs, particularly in December -- to look at the data at that point and see if they have to do more. But they don't feel any need to commit to that as of last September." (See MNI POLICY: Fed In No Hurry But Committed To Taming Inflation)

He questioned the usefulness of financial conditions indexes for guiding monetary policy, warning that reacting to equity-heavy gauges inflated by the AI boom is a "hazardous game" that could force policymakers to reverse course erratically.

PATH TO 2.5%

Current policy restraint and fading one-off shocks should pull core PCE down to 2.5% by end-2027, said Bullard, dean of the Mitchell E. Daniels, Jr. School of Business at Purdue University. That would be a much-needed result after years of above-target inflation that he said could undermine the Fed's credibility. 

"This December will be the fourth year in a row where core PCE inflation has been 3% or higher. No progress over that period is very disturbing."  

The Middle East war will likely settle down to a long-simmering conflict, and China's resuming open-market oil prices will push prices higher again, he said. 

"That would be a one-time move to a higher level of oil prices, which would have a one-time impact on inflation. The committee then has to wait for that one-time impact to go away. They've been telling that story for a long time, and that's where the insurance policy comes in. They're trying to move the policy rate up to make sure that doesn't get embedded in inflation measures." 

Bullard also pushed back against the idea that monetary policy transmission has weakened in an economy increasingly driven by AI investment, adding that hyperscalers are more rate-sensitive than commonly assumed because they are borrowing to fund data center buildouts.

RISKS TO OUTLOOK

Compounding the Fed’s task is the worsening domestic and global backdrop. With U.S. budget deficits running near 6% and neither political party campaigning on fiscal discipline, Bullard said investors are entirely justified in demanding higher risk premia on Treasuries. 

Bullard named three major risks could upend the outlook: a sudden puncture of the AI bubble, an escalation of geopolitical tension in the Middle East and beyond, and a renewed European sovereign debt flare-up centered on political stalemate in France.

"The ECB is not inclined to try to help, especially a major player like France. Even if you thought a new government was going to do something, that's quite a ways away, so markets have to survive over the next six months."  

RPT-MNI SOURCES: Bond Selloff Clouds ECB Dec Rate Call

Higher bond yields and nerves over France's fiscal trajectory mean that what was previously an almost guaranteed interest rate hike by the European Central Bank in December is now less certain, with officials judging that market financial tightening might now give them more time to assess the inflation outlook, Eurosystem sources told MNI.

“The situation isn't right for raising rates [at the ECB’s meeting on Oct 27], but looking beyond that makes little sense right now,” said one source, with other officials noting that the latest inflation data remain a concern, with consumer prices jumping an annual 3.8% in September, but that while pressures are building there are still no signs of second-round effects.

Higher yields have bought the ECB time following its 25-basis-point hikes in June and September which took the deposit rate to 2.5%, though policymakers need to remain vigilant about price pressures spreading beyond energy, another source said. Brent crude is now trading at about USD115 a barrel, up about USD45 from prices before the U.S.-Israeli attack on Iran in late February, whereas European gas contracts are 240% higher at EUR95 /MWh.

But December’s decision is now more open, sources said, stressing that the ECB should not be seen as following a mechanical path towards further tightening.

“The decision on rates?” one source said. “Even more likely to hold in October with a hike coming in December. I don't see that changing at all. But I can now see a two-sided risk developing to that, although by far the greater chance is on a hike.”

The decision will depend on incoming data and the Governing Council's analysis at the time, the source added.

“Meeting by meeting means meeting by meeting like Brexit means Brexit. Markets have a view but we also form views and if those views differ from the markets - and the day those views differ from the markets you will know it,” another source said, arguing that the Governing Council must retain the freedom to surprise markets if its assessment of the data differs from investors' expectations. (See MNI SOURCES: ECB Likely To Wait Till December Before Next Hike)

ELEPHANT IN THE ROOM

France's political and fiscal difficulties will be the elephant in the room at this week’s ECB meeting, with the topic not making it into the official agenda but potentially forming part of the wider economic and financial outlook discussion.

Sources do not expect a change in the central bank's statement, and any reference to the issue would come in ECB president Christine Lagarde answers to journalists. The ECB is likely to repeat phrasing which has featured in recent statements that its existing instruments, such as the Transmission Protection Instrument, remain available to ensure that inflation stabilises at target and to preserve the smooth functioning of monetary policy transmission

While sources acknowledged that a point could eventually be reached where market pressures spiral out of control, they stressed that there was no specific yield or spread level at which the ECB would automatically intervene or how. The official position is that the situation must be addressed by the French authorities.

“The French situation will be part of the rounded discussions, no doubt, but will be framed in the response arc of still for the French government to deal with,” one source said, with others pointing to the low incentives for the central bank to address a yield blow out clearly related to high debt levels and borrowing.

 Policymakers are aware the rise in French yields has occurred in the context of wider increase in borrowing costs, while any eventual ECB bond market response would depend on whether pricing becomes dysfunctional, rather than on a predetermined numerical threshold.

MNI SOURCES: Bond Selloff, France, Clouds ECB Dec Rate Call

Higher bond yields and nerves over France's fiscal trajectory mean that what was previously an almost guaranteed interest rate hike by the European Central Bank in December is now less certain, with officials judging that market financial tightening might now give them more time to assess the inflation outlook, Eurosystem sources told MNI.

“The situation isn't right for raising rates [at the ECB’s meeting on Oct 27], but looking beyond that makes little sense right now,” said one source, with other officials noting that the latest inflation data remain a concern, with consumer prices jumping an annual 3.8% in September, but that while pressures are building there are still no signs of second-round effects.

Higher yields have bought the ECB time following its 25-basis-point hikes in June and September which took the deposit rate to 2.5%, though policymakers need to remain vigilant about price pressures spreading beyond energy, another source said. Brent crude is now trading at about USD115 a barrel, up about USD45 from prices before the U.S.-Israeli attack on Iran in late February, whereas European gas contracts are 240% higher at EUR95 /MWh.

But December’s decision is now more open, sources said, stressing that the ECB should not be seen as following a mechanical path towards further tightening.

“The decision on rates?” one source said. “Even more likely to hold in October with a hike coming in December. I don't see that changing at all. But I can now see a two-sided risk developing to that, although by far the greater chance is on a hike.”

The decision will depend on incoming data and the Governing Council's analysis at the time, the source added.

“Meeting by meeting means meeting by meeting like Brexit means Brexit. Markets have a view but we also form views and if those views differ from the markets - and the day those views differ from the markets you will know it,” another source said, arguing that the Governing Council must retain the freedom to surprise markets if its assessment of the data differs from investors' expectations. (See MNI SOURCES: ECB Likely To Wait Till December Before Next Hike)

ELEPHANT IN THE ROOM

France's political and fiscal difficulties will be the elephant in the room at this week’s ECB meeting, with the topic not making it into the official agenda but potentially forming part of the wider economic and financial outlook discussion.

Sources do not expect a change in the central bank's statement, and any reference to the issue would come in ECB president Christine Lagarde answers to journalists. The ECB is likely to repeat phrasing which has featured in recent statements that its existing instruments, such as the Transmission Protection Instrument, remain available to ensure that inflation stabilises at target and to preserve the smooth functioning of monetary policy transmission

While sources acknowledged that a point could eventually be reached where market pressures spiral out of control, they stressed that there was no specific yield or spread level at which the ECB would automatically intervene or how. The official position is that the situation must be addressed by the French authorities.

“The French situation will be part of the rounded discussions, no doubt, but will be framed in the response arc of still for the French government to deal with,” one source said, with others pointing to the low incentives for the central bank to address a yield blow out clearly related to high debt levels and borrowing.

 Policymakers are aware the rise in French yields has occurred in the context of wider increase in borrowing costs, while any eventual ECB bond market response would depend on whether pricing becomes dysfunctional, rather than on a predetermined numerical threshold.

MNI INTERVIEW2: PBOC Needs To Aim At 2% Inflation Target

China’s central bank needs to further lower policy rates while committing to a 2% inflation target, in order to drive down real interest rates, reverse low price expectations, and counter weak domestic demand, a prominent policy advisor told MNI in an interview.

Amid the current shortfall in domestic demand, the primary objective of monetary policy should be lowering real interest rates to stimulate private sector investment, which requires both reducing financing costs and lifting inflation expectations, said Zhang Bin, deputy director at Institute of World Economics and Politics at the Chinese Academy of Social Sciences.

The recent pickup in producer price inflation is largely tied to energy and upstream supply chains, such as for integrated circuits and semiconductors, but consumer price inflation remains subdued at around 1%, a situation likely to persist without additional policy support, he said, adding that the low rate of increase in prices is also depressing expected returns for household home purchases and on corporate capital expenditure.

"To generate endogenous growth momentum, a decline in real interest rates cannot be avoided," Zhang said. The People’s Bank of China must make a firmer commitment to a future inflation path and strive to hit the 2% inflation target if it is to guide price signals and expectations more conducive to corporate investment and home purchases, he said. (See MNI INTERVIEW2: China Needs Monetary Easing To Boost Growth)

His comments come as other advisors and economists have told MNI that the PBOC is likely to hold its policy rate unchanged over the rest of the year, though it could still reduce banks’ reserve requirements, amid concerns that any broad easing could undermine the drive towards economic restructuring and boost bubbles in areas like AI. (See MNI: PBOC Seen Holding Rates, But Reserve Ratio Cut Possible)

YUAN

Nominal rate cuts must outpace the drop in inflation expectations to stimulate private sector spending, said Zhang, pointing to the property sector as an example. If people anticipate that rents will stagnate, few will buy real estate, he noted.

Weak domestic demand has also weighed on the pace of yuan appreciation. From 2005 to 2019, the yuan appreciated by an average of 3% annually, but in recent years, neither the yuan nor its real effective exchange rate has shown substantial appreciation, while nominal effective exchange rate gains have also been modest, Zhang said, noting that market participants are reluctant to hold yuan-denominated assets in an environment of deficient domestic demand and depressed corporate profitability.

"If China emerges from weak domestic demand and the yuan returns to its historic track, the currency could appreciate at an annual rate of 3%,” he said.

More than 85% of the slowdown in consumption growth can be traced to sluggish nominal GDP growth, which has slowed growth disposable income, Zhang mentioned

For several years, the nominal GDP deflator has lingered around -1%. Under a reasonable level of aggregate demand, the deflator would rebound from -1% to 2%, adding three percentage points to nominal GDP growth. If prices were to rise by three percentage points and real output were to expand by 1.5 percentage points, nominal GDP growth could accelerate by 4.5 percentage points, Zhang said. 

Addressing concerns that rate cuts would further compress commercial banks' net interest margins, he pointed out that lower interest rates could help lenders improve asset quality and reduce non-performing loan ratios.