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Staying the course – again!

The highlight of the past week was the RBNZ’s April Monetary Policy Review. As we discussed in our review note, the RBNZ disappointed markets looking for a dovish tilt. Conversely, we were not at all surprised at the RBNZ’s unchanged stance and outlook, and we haven’t changed our forecasts for the OCR to remain on hold through 2024, with the first cut to 5.25% in February 2025. We think that the extremely brief length of the press statement (140 vs 309 words in February) tells us that the RBNZ really had little to say on top of the story presented previously.

It seems the RBNZ largely agreed with our read on the dataflow since the February Statement. GDP data for Q4 were a touch weaker than forecast, while confidence indicators show the shine is coming off a bit such that a pickup in growth in H2 might be less certain. Meanwhile, the inflation picture looks less favourable than the RBNZ hoped. Given recent monthly price index data, the near-term CPI outlook seems stronger than the RBNZ expected. In addition, the exchange rate is weaker, energy prices are a lot higher, and pricing indicators in sentiment surveys point to lingering cost pressures.

This weaker growth momentum/stronger short term inflation picture is leading to a broadly unchanged stance. Reasonable people can argue over whether that stance is a smidge more hawkish or dovish overall – there’s certainly been plenty of debate about that small point around here!

This still leaves a yawning gap between where market perceptions of the path the OCR will follow over the balance of 2024 (first easing by October and 50bp by the end of the year) compared to our forecasts and those of the RBNZ (first 25bp easing in Q1/Q2 2025). We think that’s a very big gap to fill which raises the question on what it might take to shift the RBNZ closer to market views?

A dovish pivot could occur once the RBNZ gains sufficient confidence that inflation will reach the 2% target midpoint acceptably quickly. Right now, that expectation is that inflation will reach 2% by end of 2025, conditional on keeping the OCR at 5.5% until 2025. In the near term, attention will focus on the March quarter CPI (17 April), where the level of core inflation will be especially key; and the March quarter labour market reports (1 May), where long awaited signs of labour market adjustment will be sought.

However, time is getting short to influence those H2 2025 outcomes. The RBNZ pragmatically acknowledges this in the record of meeting by noting that while they have limited tolerance to extend the horizon to when 2% inflation is expected to be reached, there are three criteria that could extend that timeframe and hence allow for earlier than otherwise easing. They are: headline inflation needs to be inside the target range; inflation expectations should no longer be elevated; and pricing intentions are no longer elevated.

We think it will be very difficult to meet these tough conditions to allow easing to come as early as August. Headline inflation is forecast to be inside the target range in Q3 2024, but the RBNZ will not know if this has occurred until October. Similarly, inflation expectations and pricing intentions are around one standard deviation above their average since 1995 (as shown in the ‘Chart of the week’) and in our judgement might not reach those levels for at least six months.

This all points to a November easing as a best-case scenario, which implies a maximum of 25bps of easing in 2024. We are currently more pessimistic than this best-case scenario given recent trends in non-tradables inflation and the labour market. This means that we don’t see New Zealand as the vanguard of advanced economy policy easing (Switzerland has already eased, and there are prospects of policy easing in Canada and the euro area soon). The relatively high level of core inflation in New Zealand compared to the long-term average is in part driven by a relatively weak fiscal position. It helps explain the RBNZ’s tardy pivot to easing, despite having been one of the earliest advanced country central banks to begin tightening.

Last week the ongoing surge in inward migration prompted the Government to tighten some of the criteria for work visas. For the Accredited Employer Work Visa (AEWV), the requirements to show work experience and qualifications have been tightened. And for lower-skilled jobs, the English language requirements have been strengthened and the maximum length of stay has been shortened. The AEWV currently accounts for around 30% of migrant arrivals (including the partners of workers). We have not revised our migration forecasts because of these rule changes. Our view is that migration inflows will slow over the course of this year, but we think that deteriorating work prospects as the economy slows will be the more important determinant of migrant movements.

On the data front, last week the NZIER’s QSBO survey indicated that business confidence came back down to earth with a thud in March, after a strong bounce last December. Businesses reported much tougher conditions over the last quarter and were downbeat on their investment and hiring plans. We were wary of the previous quarter’s results, which may have reflected initial hopes about the election of a centre-right government. The other positive factor at the time was the sense that inflation was finally easing from its highs. However, the latest survey showed that firms are finding that cost pressures have been slow to recede.

General business sentiment fell to a net -24% in March, from -10% in December. That was still an improvement on the pre-election readings of -50% or worse. However, firms’ own trading activity (which has a closer relationship with GDP growth) was sharply lower. A net 23% saw worse results over the past quarter, the weakest reading since the Covid lockdown. Expectations for trading activity over the coming months also turned negative again. These results present some downside risk to our near-term GDP forecasts, where we expect some weakly positive growth (though remaining below population growth).

As far as inflation is concerned, a net 35% of firms reported that they had increased their prices in the last three months, down from 39% last quarter. Intentions to raise prices also receded modestly, from 36% to 32%. This softening comes as capacity pressures for businesses have continued to fade. The ease of finding workers remained at its highest levels since 2010, and a lack of demand is increasingly becoming the main constraint on growth. Even so, cost increases over the last three months remained high, and expectations ticked higher again this quarter. Our discussions with businesses have revealed concerns about costs such as a sharp rise in council rates and a potential rebound in shipping costs.

In the week ahead, we expect the March quarter inflation report (out on Wednesday) will show that consumer prices rose 0.8% in the first three months of the year. That would see the annual inflation rate drop to 4.2%, down from 4.7% at the end of 2023. This outcome will be stronger than the RBNZ’s most recent published forecast for a 0.4% increase. However, the RBNZ’s recent policy statement indicated that they are braced for a higher result on the day reflecting the firmness in monthly price data since their forecast was finalised back in February. The key issue will be the composition of inflation. We expect this week’s update will show that non-tradables inflation has remained sticky in the early part of the year, with measures of core inflation lingering around 4%.

Economics

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