Emissions Trading Scheme
No significant new information has come to light as regards the inflationary impact of this. However, we think the RBNZ is underestimating the effects. They themselves highlight this possibility as an upside inflation risk.
Fiscal
The RBNZ noted "additional fiscal stimulus" as a risk, and also that it could occur earlier than assumed: "fiscal stimulus occurring once inflation pressures have clearly eased is likely to be of less concern". The RBNZ is unlikely to be delighted by reports that tax cuts could well be rushed through under urgency as early as October this year. We also agree that given the healthy fiscal position and a sharply slower economy the stimulus could be considerably bigger than the RBNZ is currently assuming.
NZD
The RBNZ noted that "even if other things pan out largely as assumed, an additional risk is that the New Zealand dollar depreciates faster than we have assumed." So far, this has not been the case, but it certainly remains a pertinent risk.
Conclusion
All up, the Reserve Bank remains firmly in "wait and see" mode - as they have reconfirmed in speeches and presentations since the March MPS. The market is not expecting a change in the OCR at next week's meeting, and we concur. The main interest in the OCR review is therefore the tone of the document. We expect the balance will be tilted towards recognising that downside risks to near term growth both in NZ and abroad have intensified, while acknowledging that the inflation picture is still a problem. In the June MPS we would expect rate cuts to be brought forward from their current projection of end-2009, but to nowhere near market pricing, which suggest cuts as soon as October this year.
