Weekly Economic Commentary 10 October 2022
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
Read full report here (PDF 985KB).
Another 50 points, and even more to come.
As expected, the Reserve Bank of New Zealand raised the Official Cash Rate by 50 bp at its October policy review. That was the fifth 50 bp move in a row and took the cash rate to a seven year high of 3.50%. The RBNZ also repeated that it would continue moving “at pace” until it’s satisfied that interest rates are high enough to bring inflation back to target.
The October statement didn’t give any direct indication of where exactly the RBNZ now thinks the peak in the cash rate will be. That’s understandable: October’s policy review didn’t include a full set of new forecasts, and it’s not really desirable for the RBNZ to be drawing conclusions about work that hasn’t been done yet.
However, the record of the meeting was unusually explicit in one respect, noting that the Committee had debated between a 50 or a 75 bp hike this time. The latter was argued on a ‘stitch in time’ basis: a larger increase now could reduce the need for a higher peak in the OCR cycle overall. This is the same reasoning that was applied when the RBNZ switched up from 25 to 50 bp moves earlier this year. So this was effectively a ‘hawkish’ shift in the RBNZ’s thinking, without being too precise about the scale of it.
The RBNZ’s comments strongly suggest that they now expect a higher peak in the OCR than they did before. In the August Monetary Policy Statement, the RBNZ projected a peak of just over 4% by the second half of next year. If that was still the peak that they had in mind, then moving to 3.75% at the October review would have done very little in terms of trimming the amount of tightening they ultimately need to do. Stepping up the pace of rate hikes – or even discussing it – makes more sense in an environment where the RBNZ is quite some distance from where it thinks it needs to be.
A key point to take from the October statement is that the RBNZ is firmly focused on setting monetary policy for local conditions. The statement was filled with references to strong demand, constrained capacity, labour shortages, and elevated core inflation. There was much less emphasis on overseas conditions, or – surprisingly to us – the sharply lower exchange rate over recent weeks.
Looking at local developments since the RBNZ’s previous policy statement in August, we have seen some signs that the economy is starting to lose steam. Most notably, the housing market has continued to cool, with prices now down 9% since their peak in November. We’ve also seen a flattening off in nominal spending at the same time that prices and earnings have been rising rapidly.
However, while signs of a slowdown are taking shape, overall economic activity has continued to run hot. That’s been seen most clearly in the labour market with continued strength in filled jobs, high levels of staff turnover, and a rise in job advertisements. We’re also continuing to hear reports of strong increases in wage rates.
Looking at economic conditions more generally, the latest NZIER survey of business opinion has seen businesses continuing to report firm levels of demand and ongoing pressure on operating capacity. Businesses are also continuing to report significant pressure on operating costs, with very large numbers passing those increases into their output prices.
With activity remaining resilient and inflation pressures still red hot, we recently revised up our forecast peak in the current cash rate cycle to 4.50% (up from 4.00% previously). We expect that to be achieved with 50 bp increases at both the November and February policy meetings.
Given the extend of the price and cost pressures rippling through the economy, there have been questions about whether even a 4.50% cash rate will be enough to tame the inflation dragon. Those concerns have been reinforced by the resilience in activity over the past year as the OCR has continued to push higher. However, there are a couple things to keep in mind on this front.
First, a sizeable chunk of the cost pressures that we’ve been grappling with have been due to global disruptions that occurred as a result of the pandemic. That includes interruptions to global manufacturing and distribution networks, as well as increases in the prices of commodities like oil. Some of those pressures are continuing today, with the prices for many imported consumer goods and production inputs lingering above their pre-pandemic levels. Even so, we’re not seeing the same sort of very large increases that we did over the past year. And in the case of global oil and shipping costs, there have been sizeable falls in recent months.
Second, and importantly for domestic monetary policy, is that the full impact of interest rate increases to date has yet to be felt by many households. Around 90% of New Zealand mortgages are on fixed rates. That’s meant many borrowers have been insulated from the impact of rate increases thus far. But that picture is now changing, with around half of all mortgages coming up for repricing over the coming 12 months. In many cases, borrowers will face refixing at rates that are 2% to 3% higher than the rates they are currently on. That signals a significant squeeze on many households’ disposable incomes, and the related easing in demand will go a long way to dampen the domestic inflation pressures the RBNZ is grappling with.
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