All eyes on interest rates for next two years

Despite the RBNZ’S claim of the ‘spurious accuracy’ of the OCR track, or the complete 180 degree turns from previous OCR tracks, it’s the best mud map the central bank can provide for the future path of rates, Jarrod Kerr, Kiwibank chief economist says. 

“One we can then pick apart and debate.”

He is expecting to see the OCR track pushed lower and pulled forward given the RBNZ has delivered more cuts than it anticipated in August.

Also, it is a long time until the country hears from the Reserve Bank again.

“Practically a whole season of waiting until its next rate decision in February. And a lot can happen between now and then.”

Kerr says by then, there will have had a completely refreshed suite of data on economic activity, inflation and the labour market. Not to mention a Trump inauguration and “god knows what else”.

“But for now, if the data plays out how we expect it to, then we still think another 50bps cut in February should be delivered.”

He says with the 2% target inflation rate well within reach, Kiwibank believes the RBNZ needs to get the cash rate below 4% ASAP. “So why not get it to 3.75% in February?”

The RBNZ has kept the Kiwi economy in a chokehold over the past couple of years to kill inflation. But now, the inflation beast has been slayed.

“We need the RBNZ to loosen its grip fast – before doing any more unnecessary damage to the economy, Kerr says. 

Inflation pressures are coming off faster than expected – and Kiwibank was more optimistic than most about the return to 2%.

Meanwhile, activity has continued to frost over.

“We need rapid rate relief. And without it risk one, undershooting inflation, and two, more avoidable damage to kiwi businesses and households.

“Yeah, there are some potentially annoying complications on the horizon, from slightly higher inflation expectations, to growing talks of Trumpflation, and trade tariff wars,” he says. 

“But given the state of the Kiwi economy after two years of recession, we think more is needed, sooner rather than later.”

It is the end point that matters most

Kerr says regardless of the size of the rate cuts, it’s the end point for the cash rate which matters most.

Timing is one thing, magnitude is another.

He says if the RBNZ wants to remove the restrictiveness of interest rates, it needs to go back to a neutral setting (a Goldilocks rate that’s not too hot, not too cold).

That Goldilocks rate is estimated by the RBNZ to be about 2.75%, a long way from 4.75% today, 4.25% on 27 November, and even 3.75% in February.

“And we’re arguing the RBNZ should cut to 2.5%, the lighter side of neutral, with a hint of stimulus to get things moving.”

That’s a big move in all rates, Kerr says, including mortgages, test rates, term deposits, and business banking lending rates.

“It’s the magnitude of rate cuts that impacts business decisions, and household confidence.”

Confidence should be reflected in OCR track

Westpac’s expectation is the RBNZ in its OCR track will project the cash rate to decline to about 3.50% by the end of next year – around 0.35% lower than projected in the August Monetary Policy Statement (MPS).

Senior economist Darren Gibbs says that more front-loaded easing will reflect increased confidence regarding the outlook for inflation, with actual inflation tracking below the forecast made in August, even as activity and labour market trends track broadly in line with expectations.

Such a track will still imply a slower pace of easing next year.

But, he says there are other possibilities to consider.

For example, it is possible the RBNZ could project the OCR to end next year at a similar level to that forecast previously.

The recent strong lift in business confidence and improved dairy commodity prices might cause the RBNZ to take a cautious approach to further lowering the OCR, the closer it moves to the neutral zone (recognising the uncertainty that surrounds any estimate of where the neutral policy rate lies).

Concerns about the potential for weakness in the exchange rate – thus disrupting the current helpful disinflation in the traded goods sector – might also be a consideration.

On the other hand, Gibbs says it is also possible the RBNZ could lower its year-end target for the OCR.

“It might do this if recent price and wage outcomes – both slightly softer than expected – are viewed as providing a high degree of confidence that inflation will stay close to the target midpoint.

“If so, the RBNZ will likely want to more quickly move policy towards a neutral setting, so as to mitigate the possibility that a slow economic recovery could push inflation well below the target midpoint for a period.”