Weekly Economic Commentary 22 August 2022
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
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Four of a kind.
The RBNZ has delivered a fourth consecutive 50bp rate hike, and the accompanying policy statement fully endorsed Westpac’s forecast for two additional 50bp hikes by the end of this year. Inflation pressures have been bubbling over and the RBNZ is set to continue with its ‘go hard and early’ approach over the course of this year. However, there are signs that demand is already starting to cool and a slowdown in growth is on the cards over the coming months. That will likely see the RBNZ shifting to an on-hold stance from the end of this year.
As expected, the Reserve Bank of New Zealand raised the Official Cash Rate by 50bps at its August policy meeting. That was the fourth consecutive 50bp rise and took the cash rate from 2.50% to 3.00%, its highest level in seven years.
An August rate hike had been well telegraphed. Consequently, the main focus was on what the RBNZ signalled going forward. On this front, the RBNZ’s published projections and the accompanying commentary fully endorsed Westpac’s forecast for two additional 50bp moves and a 4.00% peak in the cash rate by the end of this year.
The RBNZ’s updated forecasts now show the cash rate peaking at 4.1% (up from 3.9% in their previous projection) with the cash rate also rising at a slightly faster pace than previously assumed. Underlying that higher projection for the cash rate was a hawkish assessment of recent economic developments, with the policy statement highlighting the tightness in the labour market and strength of domestic inflation pressures. Consistent with the hawkish assessment, the minutes from the August meeting noted that the Monetary Policy Committee agreed to bring forward the timing of OCR hikes. In addition, the Committee noted that “maintaining the recent pace of tightening remains the best means by which to meet their Remit.” All of that is in line with our forecasts for continued large increases in the cash rate over the remainder of this year.
The RBNZ’s updated projections did leave open the possibility that the size of rate increases could slow to 25bps by the end of this year, and that rate hikes could continue into next year. There certainly are some big question marks surrounding the longer-term outlook, including the strength of domestic demand and the state of the global economy. And a more measured pace of rate hikes would give the central bank time to take stock of whether the last few increases really will be required.
However, while the RBNZ has that flexibility if needed, we think they will continue with their current ‘go hard and early’ approach of 50bp moves. The strength of inflation has surprised the RBNZ and analysts alike, and it’s set to remain above the RBNZ’s target band for at least the next year. That is a big concern. Such a protracted period of strong price growth risks expectations of high inflation becoming embedded into households and businesses’ behaviour. And that could result in serious long-term damage to the economy, including the risk of a wage-price spiral and the erosion of households’ purchasing power. To offset those risks, the RBNZ is more likely to frontload rate increases to get the inflation genie back in its bottle.
Reinforcing the case for continued large rate moves is the uncertainty about where the ‘neutral’ level of the cash rate is. The neutral cash rate is the level of the OCR that is neither accommodative nor restrictive. When the OCR is above neutral, interest rates will tend to be a drag on demand. Conversely, when the OCR is below neutral (as it has been through much of the pandemic) the low level of interest rates will boost spending and activity. Right now, with domestic demand running hot and inflation bubbling over, the RBNZ is desperate to ensure that the cash rate has moved above neutral and into tight territory to cool the economy down.
Even in normal times, there are wide bounds of uncertainty around where exactly the neutral rate sits. And right now, we are a long way from normal. The neutral level of the cash rate in New Zealand is usually thought to be around 2%. However, the RBNZ has flagged the possibility that at the current time that level could be higher than usual (meaning that more policy tightening could be required). Given that uncertainty, the RBNZ are likely to continue with large and rapid rate hikes to ensure that the cash rate is having the intended dampening impact.
While we’re forecasting rapid rate increases in the near term, there are signs that demand is already starting to cool and a slowdown in growth is on the cards over the coming months. As we’ve previously highlighted, the impact of rate increases to date has been blunted by mortgage rate fixing. However, a large number of mortgages will come up for repricing at substantially higher rates over the coming months. The related pressure on households’ budgets will squeeze demand and help to bring inflation pressures to heel over the coming years. That will likely see the RBNZ shifting to an on-hold stance from the end of this year, capping the rise in the OCR at 4%.
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