Bets are on for OCR to fall even further

The latest inflation rise centred around food prices, electricity and local council rates.

Subdued price pressures in the discretionary and more cyclical areas of the Consumer Price Index (CPI) are significant for the RBNZ, Westpac says.

Senior economist Satish Ranchhod says combined with the expected easing in food prices, overall inflation is expected to drop back to levels comfortably within the RBNZ’s target 1-3% band over the year ahead.

That is despite the continued firmness in regulated prices, which don’t respond to monetary policy.

He says while there are continued large price increases in some areas, underlying the surface the broader picture of price pressures is a lot better contained.

There has been particular weakness in housing costs, which account for around 20% of the CPI.

In annual terms, rental inflation has fallen to its lowest level since 2019 and construction cost inflation is at its lowest level since 2009.

That weakness comes against a backdrop of low population growth and a sharp downturn in building activity.

Inflation in both of those areas is expected to remain modest over the year ahead.

With the medium-term inflation outlook contained and the economy still operating with spare capacity, that gives the RBNZ headroom to continue cutting the OCR, Ranchhod says.

Westpac is forecasting one more 0.25% rate cut at the November meeting, with the OCR expected to bottom at 2.25%.

He says key to how far the OCR falls will be how the economy responds over the next few months.

“It’s true that domestic activity has been sluggish recently. However, New Zealand has about 90% of mortgages that are fixed for a period.

“As a result, while interest rates have been dropping since August last year, we’ve only really seen a material fall in households’ debt servicing costs since about the middle of this year.”

He says with a large amount of stimulus now hitting the economy’s blood stream, the bank will be watching for signs that spending is starting to turn as the country heads into the summer months.

“We’ll also be keeping a close eye on gauges of the job market, with the September quarter labour market update out on 5 November,” Ranchhod says.