RBNZ piloting a plane without knowing how hot the engine is running

Economists are divided on whether the Reserve Bank will lift the OCR or leave it at 5.5% at its review on Wednesday.

Westpac Bank expects it to remain at 5.5%, with most interest centering on the profile for interest rates this year and beyond. However there is a 25% probability of a hike, Kelly Eckhold, Westpac’s chief economist says.

“We think the RBNZ’s objective will be to try to maintain the recent repricing in financial markets which has removed the expectation of rate cuts until at least the end of this year.”

He says the option to tighten at the May monetary policy statement will probably be left open by the RBNZ should the data warrant it.

“The RBNZ will be on edge due to some aspects of the recent data flow – even though a straight read of the entirety of that data probably shouldn’t increase concerns inflation will move back inside the 1-3% target range.”

More concerning inflation factors have been balanced to some extent by the significantly lower headline inflation outcome and much weaker GDP and economic momentum, Eckhold says.

The key issues raising those concerns are the slower than expected increase in unemployment (which will likely require a further adjustment of its labour market forecasts to push out the period over which the labour market adjusts) and higher than expected domestic inflation.

“If the RBNZ adjusts up its first quarter domestic forecast to Westpac’s own level of +1.4% q/q, 5.6% y/y vs. RBNZ November statement of 1% q/q, 4.9% y/y, this will further amplify their concerns that domestic inflation won’t subside quickly this year, he says. This approach will be consistent with continuing with the “longer” rather than “higher” strategy in place since May last year.”

Maintaining pressure

It is the RBNZ’s bite rather than its bark, which sent shudders through the financial markets, that people should be afraid of, says Kiwibank chief economist Jarrod Kerr.

While Kiwibank expects the RBNZ to hold the cash rate, as it is high enough, it is predicting an OCR cut in November, well ahead of the RBNZ’s current OCR track, which has no cut until September next year.

Kerr says although inflation is falling, domestically generated pricing is sticky. “Market traders largely ignored the RBNZ’s warnings in November. And there is a risk, if the RBNZ pauses again, interest rates will fall in anticipation of cuts.”

He says a hawkish stance can be maintained, by simply doing nothing.

“The threat of another hike may lose some weight with an ‘on-hold’ decision. But the higher-for-longer OCR track, which signals no cuts until late next year, will keep wholesale rates in check for now, he says.”

The market reaction to an on-hold decision will be one of rate relief. Even the most hawkish hold will see some decline in wholesale rates. If it doesn’t hike now, it is less likely to hike in May, Kerr says.

November rate cut

Also predicting a rate cut in November is the BNZ. In the meantime, chief economist Mike Jones expects the OCR to stay at 5.5% for reasons which include:

  • Concrete production fell 4.6% in Q4 of last year to be 12% down on a year ago.
  • Inflation expectations fell. The two-year expectation dropped to 2.50% from 2.76%, the five-year to 2.25% from 2.43%, the 10-year to 2.16% from 2.28%.
  • Wage inflation expectations fell to their lowest level since Q2 2021, at 2.99% and house price inflation expectations fell to 5.78% from 6.22%.

Jones says while the Reserve Bank has been concerned rising net migration is becoming inflationary, the latest data suggest it is diminishing and the government is making noises that it is perturbed by the pace of inbound migration and will look to moderate the inflows.

“Putting this all together, we acknowledge there is more of a chance the RBNZ lifts its cash rate on Wednesday than it lowers it. We strongly believe that to raise rates at this juncture will be a policy mistake.

“That said, we also believe the Reserve Bank will aggressively justify holding interest rates at current levels for an extended period. Consequently, we are moving our first projected rate cut back to November 2024.”

Long way to go

ANZ chief economist Sharon Zollner says capacity pressures need to weaken further to get inflation sustainably back to 2%.

“It’s more challenging than usual for the RBNZ to calibrate its policy response, given the large shocks that are still buffeting the economy and old pandemic-era shocks that are still working their way through.”

Zollner says there are two views. One, that the economy is not only weak but going downhill fast, the other, that while monetary policy is working – still-stimulatory fiscal policy and strong population growth are meaningful offsets meaning much of the economy is still ticking along. And with inflation looking sticky, that could be a problem.

“The weakness we see this year is predicated on two more OCR hikes that could have a chilling impact on tentative green shoots in property and investment by reintroducing two-way risk when the general consensus has been that interest rate cuts were just a matter of time.

“In short, we are taking the RBNZ at its November word that its patience is running out with the slow progress in getting domestic inflation lower, and we see the data since then as tilting towards slower yet.

“The overarching story of our forecasts is therefore 2024 as a year of subdued activity, 2025 as the year of recovery, and 2026 as the mythical return to equilibrium.”

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