The base case was the Reserve Bank would hold its official cash rate (OCR) at 1.75% this year, not lifting it until February next year.
However, the balance of risks in the coming six months seemed more tilted towards a cut than a hike — although both seemed low chances, he said.
The hurdles for the Reserve Bank cutting rates seemed very high.
"That said, in an environment where headline inflation is very low — and the Reserve Bank projects will remain below the midpoint for several years — and the dollar relatively strong, we suspect the market will be more sensitive to downside data surprises."
The central bank did not expect Consumer Price Index inflation to reach the 2% midpoint until the third-quarter of 2020, about two and a-half years away.
Core inflation had been unchanged at 1.4% for nine months. Before Mr Orr released the May Monetary Policy Statement, he would sign a new Policy Targets Agreement with Finance Minister Grant Robertson.
The present agreement made specific reference to the 2% target midpoint.
There was a good chance the reference to the 2% target would be retained, as eliminating it might affect inflation expectations. In the present environment, it might create a perception the Reserve Bank was comfortable with CPI persistently towards the lower end of the target range, Mr Smyth said.
"We don’t pretend to know how the new governor might see the outlook, nor for how long he will be comfortable with the CPI below midpoint.
"But if CPI and gross domestic product [GDP] are in line with our expectations, there has to be some risk the Reserve Bank extends the timeframe for reaching 2% inflation."
The May MPS, although some time away, shaped up as a major risk event as the market would receive inflation and cash rate projections from the Reserve Bank for the first time under Mr Orr’s leadership.
Potentially marketing moving events before May included the ANZ Business Survey on Wednesday, GDP on March 15 and the OCR review on March 22.
The Reserve Bank last week released its survey of expectations showing a slight rise in the rate of inflation over the next couple of years. A Forsyth Barr research report said the central bank would note the expectation of house price inflation increasing from 2.01% in November to 2.52%.
"Rising house prices is something the central bank will watch closely, especially given the number of changes the Government is pushing through in this sector."
Commentary and headlines concerning higher interest rates had been commonplace recently but New Zealanders were not big purchasers of US Treasury bills, Forsyth Barr said. New Zealand’s five-year swap rate, which was the base for much of the corporate credit Kiwis bought, was only up 3 basis points year-to-date.
There were also ongoing tight credit spreads as the current lack of issuance continued, keeping corporate bond yields low.
