MNI INTERVIEW: Aussie-NZ Spread To Widen, RBNZ Less Hawkish

The spread between Australian and New Zealand official rates is likely to widen further this year, with markets probably overestimating the Reserve Bank of New Zealand’s hawkishness given a weak economic backdrop, a former Reserve Bank of Australia official told MNI.

“Even talking about [RBNZ] rate hikes in the next few months just sounds diabolically stupid to me, given the interest rates that actually matter have already gone up quite a lot,” said Justin Fabo, founder of Antipodean Macro and the RBA’s former head of international financial markets, pointing to New Zealand’s rising mortgage rates. “I'm either very, very wrong or thoroughly confused.”

While the RBNZ Monetary Policy Committee voted unanimously to hold the Official Cash Rate at 2.25% last Wednesday, markets interpreted the subsequent press conference and Governor Anna Breman’s tone as hawkish, with overnight index swaps rising 2-10 basis points across meetings. (See MNI RBNZ WATCH: MPC Discussed Front-Loading Hikes) Markets have now fully priced in a hike by July, with the OCR seen at 3% by December, while the New Zealand dollar has strengthened against the Australian currency about 0.8% following last week's meeting.

Fabo pointed to stagnant core inflation despite higher headline readings and Breman's focus on price expectations. “A zero chance? It’s definitely not zero. But given they themselves talked about a very early-stage recovery, the risk of shutting that down is real. Financial conditions have already tightened. Why would you start lifting the policy rate? Unless they have a lot more confidence that unemployment will keep falling, which I don’t think they do.”

He said the RBNZ might be tempted to hike by September at the earliest, but market pricing looked excessive. There was a 30-40% chance of a hike before then, "not anything close to fully priced,” he added, noting the Bank risked damaging the economy if it became too reactive to inflation.

RBA STRATEGY

By contrast, the Reserve Bank of Australia is more likely to continue tightening, with the cash rate expected to rise at least twice more from 4.1%.

“They’re probably first in the queue of wanting this [Iran] conflict to be over so they can get back to their narrative of needing tighter policy,” Fabo said, noting the Board's split vote at its latest meeting would likely have not occurred without the Middle East war. (See MNI RBA WATCH: Timing Drove Split Vote, Not Direction-Bullock)

However, prolonged geopolitical tensions could complicate the outlook, weaken the labour market and lead the RBA to err on the side of supporting activity and employment, he argued. “If everything turns really pear-shaped and drags on, then sure — central banks are cutting, not hiking. But I think the baseline is that this is temporary,” he continued.

Fabo believes geopolitical incentives suggest the conflict may not persist for an extended period. "If that’s right, the economic effects should fade fairly quickly,” he concluded.