Weekly Economic Commentary 20 March 2023
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
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High-five.
With signs that the economy isn’t running as hot as we or the RBNZ thought, we have revised down our forecast for the Official Cash Rate. We now expect that the OCR will reach a peak of 5.00% (down from our previous forecast of 5.50%). That implies just one more 25bp rise in the current cycle, which we expect will occur at the RBNZ’s next policy meeting in April.
For the past 18 months, the Reserve Bank of New Zealand has been hiking the Official Cash Rate at a rapid pace against a backdrop of an overheating economy and a related surge in inflation. And at the time of its last policy decision in February, the RBNZ remained resolute that further rate increases would be needed to get inflation back inside the target band. The forecasts that accompanied their February policy statement showed the cash rate rising from 4.75% to a peak of 5.50%. At that time, we broadly agreed with that assessment.
However, recent updates have cast fresh light on the strength of economic conditions. Although activity remains elevated, GDP figures for the year to December 2022 have shown that the economy is not running as hot as we or the RBNZ had thought. Economic output fell by 0.6% in the December quarter. That was a sharper decline than we and other analysts expected. The result was also well below the Reserve Bank of New Zealand’s forecast for a 0.7% rise in activity over the quarter.
Looking under the surface, there was widespread weakness in activity, with declines in both the goods and services sectors. Notably, there were falls in retail and accommodation spending, transport, and personal services. Those are all sectors that are benefitting from the rebound in tourism currently in train, and their recent declines highlights the softening in domestic demand.
Importantly, it wasn’t just the December quarter that has turned out softer than expected –estimates of activity through the middle part of 2022 have also been revised down. Putting that altogether, it’s turned out that GDP is running almost two percent below what the RBNZ was expecting in its February Monetary Policy Statement.
Even with the softer-than-expected end to 2022, we’re still left with a picture of an economy that is highly stretched, with elevated levels of demand, high levels of employment, and rapidly rising prices. And that means some further rise in the OCR is still needed. However, the economy is not nearly as stretched as the RBNZ thought. That matters for how much of a slowdown – and exactly how much further interest rates need to rise – to bring inflation back under control.
We’ve revised our forecast for the peak in the OCR to 5.00% (down from 5.50% previously). That implies only one more 25 basis point increase in this cycle, which we still think will be delivered at the April OCR review.
The RBNZ won’t necessarily call time on the tightening cycle at that point – and since it won’t be publishing new forecasts at the April review, it doesn’t have to be explicit about the path forward. Rather, it could shift its language towards noting that a substantial amount of tightening has been put in place over the last 18 months, and that any further moves will be data- dependent.
In terms of what economic data is likely to show over the coming months, New Zealand is widely expected to slip into recession this year. However, the weak economic activity in the December quarter was not necessarily the start of that. In fact, some key gauges of economic activity that had softened through the latter part of 2022 – such as card spending and the PMI manufacturing survey – have actually picked up again in the first two months of this year. On top of that, the clean-up from Cyclone Gabrielle will generate extra activity that will add to GDP over the coming months. More generally, most businesses we’ve spoken to in recent weeks have continued to report firm levels of demand in recent months. Consistent with that, we expect to see continued, albeit modest, rates of economic growth through the first half of this year.
Looking further ahead, we expect economic activity to cool off through the back half of this year. Over the coming months, large numbers of borrowers will face refixing their mortgages at substantially higher rates. The resulting increases in debt servicing costs will be a substantial drag on households’ spending power and domestic demand more generally.
That downturn in domestic demand will help to dampen inflation over time. Even so we’re still looking at a strong inflation outlook over the coming year, and that’s been exacerbated by the recent storms which have seen sharp rises in the prices of items like fresh produce. Given that strength in inflation pressures (which is already feeding into higher wage claims), we don’t think the RBNZ will look at taking their foot off the brake until mid-2024 – slightly later than we previously forecast.
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