Weekly Economic Commentary 3 April 2023
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
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RBNZ to leave the door open.
We expect the Reserve Bank of New Zealand will raise the Official Cash Rate by 25 basis points at Wednesday’s monetary policy review. The bigger question is what the central bank signals going forward. We expect the RBNZ will acknowledge recent downside developments, including the volatility in the global banking system. Even so, they will continue to emphasise the strength in inflation pressures and leave the door open for further hikes.
At the RBNZ’s last policy review in February, the Monetary Policy Committee hiked the cash rate by 50bps to 4.75%. The MPC also indicated that it expected the cash rate would need to continue rising over the months ahead, with the OCR projected to peak at 5.50%.
In the weeks since the February policy statement, however, the economic landscape has become a lot rockier. Internationally, financial markets have been jolted by the collapse of several regional banks in the US and Credit Suisse Bank in Europe. The resulting concerns about the health of the global banking system and a potential tightening in credit conditions saw expectations for policy rates here and abroad pared back sharply.
While markets have calmed again, the nervousness surrounding the banking system hasn’t completely dissipated. And although financial institutions in New Zealand remain in good health, the RBNZ will be keeping a close eye on developments offshore and the potential for a turn in global sentiment. If that were to occur, it would weigh on global growth. It would also make it harder and costlier for New Zealand to access funds from overseas.
Closer to home, there’s been relatively limited economic news since the February policy decision. However, the one big piece of data that we’ve had was GDP, and that was a shocker. 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 RBNZ’s forecast for a 0.7% rise in activity over the quarter.
Importantly, it wasn’t just the December quarter that has turned out softer than expected –estimates of activity through the middle part of 2022 were also 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.
That still leaves us with a picture of an economy that is highly stretched, with elevated levels of demand and high levels of employment. Crucially, 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 estimate that the GDP surprise alone would knock about 50 basis points off the peak of the RBNZ’s rates profile. That would still make a 25bp hike at the April review a reasonable prospect, but casts some doubt about the need for further moves. Consistent with those developments, we revised down our forecast for the peak in the cash rate to 5.00% a few weeks back.
However, since that time, we’ve had a speech from RBNZ Chief Economist Paul Conway which discussed how the RBNZ views the current state of inflation pressures. That speech – which was released following the weaker than expected GDP result and volatility in financial markets – remained hawkish. It made it clear that inflation is far too high and the RBNZ remains concerned about the risk that inflation remains strong for longer. Mr Conway went on to note that “We are incredibly determined to get inflation and inflation expectations back to target.”
Given that very clear hawkish bias, we expect that this week’s policy statement will continue to highlight the RBNZ’s ongoing concerns about inflation. We also expect the RBNZ will leave the door open for further rate hikes.
How far the OCR ultimately rises will depend on how economic conditions play out over the coming months. For now, inflation remains red hot, with consumer prices up 7.2% over the past year and businesses operating costs up 8% over the same period.
But as we’ve noted previously, monetary policy acts with long lags. And while rates have been rising for more than 18 months now, much of the impact of that tightening still lies ahead of us. In fact, given the prevalence of mortgage rate fixing in the New Zealand market, most of the impact of rate hikes to date won’t be felt until later part of this year.
However, the dampening impact of rate hikes is starting to become more obvious. House prices have already fallen 17% across the country since the start of the tightening cycle. In addition, conditions in the residential construction sector are turning down rapidly. While building activity remains elevated for now, monthly consent issuance has fallen 30% over the past year and many businesses that we’ve spoken to in the sector are reporting a sharp decline in forward orders. Similarly, we’ve heard a growing number of anecdotes of softening demand in the retail sector, especially among sellers of durable items like furnishings.
As the full impact of rate hikes is felt, we expect both economic activity and the labour market will weaken materially over the year ahead, and those conditions will see inflation easing back. But until the RBNZ gets clear confirmation that the economy is slowing, it will continue to emphasise the potential for further rate hikes. And regardless of where the OCR peaks in this cycle, interest rates will likely need to stay high for some time, until inflation is clearly back on a path towards the 1-3% target range.
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