More OCR cuts to come

Moderate economic growth is on the cards, but the outlook has softened – thanks to the decline in dairy and falling business confidence – the latest ASB Quarterly Economic Forecast says.

A 6% drop in dairy production and a pull-back in investment and discretionary spending will squeeze dairy incomes and drag on GDP growth.

ASB chief economist Nick Tuffley said the bank expects overall growth to slow to a low of 2.1% in early 2016.

“But we still fully expect growth to recover over 2016, and much of the seeds for this future growth have already been sown through the considerable fall in the NZD and string of interest rate cuts.”

While net migration is still running at record levels, ASB expects it to eventually start declining and notes that when it does so it may do so sharply.

In the meantime, strong migration is fuelling an increase in the labour supply but, due to slowing labour demand, the unemployment rate is set to rise.

Tuffley said the extra slack in the labour market will keep a lid on wage inflation pressures and provide an extra drag to domestic inflation when inflation pressures are already low.

Along with the domestic risks, the global economic outlook is uncertain.

Question marks still hang over China’s slowing growth outlook, Tuffley said.

“Also, looming US interest rate increases have increased nervousness about the potential impact of capital flight on emerging economies, and rising servicing costs of USD-denominated debt.”

This combination of factors means that ASB believes the Reserve Bank has the scope to cut the OCR below 2.5%.
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The bank’s forecast is for the RBNZ to cut another 25bp in December, leaving the OCR at 2.5%.

If inflation is more subdued than the RBNZ anticipates, there is a risk that the OCR will be cut further over the course of 2016.

Tuffley said the economic backdrop means a low interest rate environment will prevail for two to three more years.

“In fact, our inflation outlook is so low now that it is screaming out for us to forecast lower interest rates than we are.”

The RBNZ could respond to the situation by cutting interest rates further or by accepting that both inflation and growth outcomes could have been more optimal.

“In the absence of OCR cuts, we sense a foregone opportunity for the economy to grow a little faster in an environment of still-benign inflation,” Tuffley said.