MNI INTERVIEW: RBNZ Hike Pricing Too High, RBA OK - Fabo

Markets are overpricing the risk of further Reserve Bank of New Zealand tightening now that oil prices are subsiding, former Reserve Bank of Australia senior economist Justin Fabo told MNI.

Fabo, founder of Antipodean Macro and the RBA's former head of international financial markets, estimates there is a 40%-60% chance the RBNZ's Monetary Policy Committee will raise the 2.25% Official Cash Rate next week, well below the market-implied probability of 74.5%. Markets are also pricing an 71.4% chance of a further hike at the subsequent meeting, implying around 36 basis points of cumulative tightening, which he said was excessive.

But, while some external MPC members have adopted a hawkish stance, any hike next week would require at least one internal member to switch sides after May's meeting split three-three, with Governor Anna Breman casting the deciding vote to keep the OCR at 2.25%, he noted. (See MNI RBNZ WATCH: Gov Breman Says Hike Incoming After Hold Vote)

"[External members] rationale for tightening was to get ahead of the inflation risks, which were driven almost entirely by the conflict-related story," he said. "Now that's largely gone away. Activity indicators have softened, at least for now, so I don't know how they would justify a hike."

The market had placed too much weight on Breman's comments after the May meeting, interpreting them as signalling a rate hike could come as soon as the next meeting, he added. While inflation remains above the RBNZ's 2% target, Fabo argued the real economy does not currently warrant tighter policy.

"If you looked only at inflation, you'd probably conclude policy is still too easy... But from a real economy perspective, I don't think the data are screaming that you need to be hiking."

Underlying economic trends had been improving before the recent geopolitical shock, with labour market indicators, GDP and migration all moving in a more favourable direction. Once the effects of the Gulf conflict fade from the data, the case for gradually removing policy accommodation later this year could re-emerge, he explained.

AUSTRALIAN PRICING

Turning to his own side of the Tasman, Fabo said market pricing for around 13bp of RBA tightening by year-end looked broadly correct. 

He expects June-quarter inflation to come in largely in line with the RBA's May forecasts, which could support a rate increase in August. However, uncertainty surrounding the economic outlook means policymakers are likely to remain cautious, particularly if recent weakness in activity proves temporary.

"I wouldn't rule out further tightening later in the year," he said. "If the recent softness outside housing is largely related to the conflict, those indicators could improve again."

The housing market will be the key determinant of RBA policy over coming months, he argued, while monthly labour market data could continue to shift market expectations. "You're one good labour market report away from market pricing reversing," he said. "But the thing that's changed a lot is housing, and it's very sick. Housing has long tentacles through the economy, and I think the Bank will be watching it like a hawk."

Offshore macro hedge funds have also been a major influence on Australian rates pricing because of their increasingly bearish view of the housing market, Fabo said. "They still think Australia has too much household debt, house prices are very high and the economy is heavily leveraged to housing," he said. "When housing turns sharply, they don't think the RBA can continue hiking."

Slowing credit growth reinforced that view, he added, noting major banks had already begun cutting lending rates independently of the RBA in an effort to attract borrowers.