Weekly Economic Commentary 14 August 2023
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
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Steady as she goes!
Last week we released our quarterly Economic Overview. The key theme was “the great rebalancing,” and we ask whether and how quickly it will occur? The economy is clearly slowing, as further demonstrated by last week’s soft retail spending and manufacturing PMI reports. However, the economy remains overstretched and inflation far too high. Twin deficits – external and fiscal – are in play, raising clear risks the required adjustments in economic conditions might be bumpy and prolonged.
Our baseline is that that further monetary policy action is needed to ensure the required adjustments come fast enough. But there are risks in both directions. On the upside, we continue to see the risk of only slow adjustments in economic activity and lingering ‘sticky’ inflation pressures, which could mean that the OCR needs to move even higher – perhaps even above 6%. But on the downside, the possibility of weaker Chinese demand could allow for a faster adjustment than we have factored in. But even then, local interest rates will likely remain higher than pre-pandemic levels.
This week the key event in the local diary is Wednesday’s RBNZ’s OCR decision and updated Monetary Policy Statement. As we wrote in our preview, we are not expecting any fireworks, with the Bank likely to deliver the same “steady as she goes” message as was conveyed last month. Specifically, the OCR is almost certain to remain at 5.5% and the Bank is very likely to retain its baseline projection that the rate cycle has peaked. Looking beyond this meeting, the Bank’s projection for the OCR will likely continue to indicate policy on hold until around the August 2024 meeting, before gradually moving lower thereafter. But it is probable – and certainly desirable – that the Bank will emphasise that policy is not on a predetermined path and that it will be closely monitoring the emerging data flow both here and abroad.
Economic developments since the July policy meeting – and since May when the RBNZ released its last set of forecasts – will likely be viewed as mixed, and so lead to only modest changes to the broad thrust of the Bank’s overall growth and inflation forecasts. That’s not to say there won’t be changes within the detail. For example, the RBNZ’s starting point for the level of excess capacity in the economy will be adjusted down to reflect that March quarter GDP was weaker than they expected. However, indicators – including robust employment growth – point to a stronger June quarter than the Bank had projected, so the implications for the output gap will likely be a wash.
Recent external sector developments will have been a downside surprise for the RBNZ. Of particular significance has been ongoing weakness in China’s recovery and the related substantial downgrade to the outlook for commodity export prices (dairy, meat, logs for example), which will lower farm and business incomes. On the other hand, house prices have found a base sooner than the RBNZ expected and have even taken tentative steps higher. And while the headline CPI was in line with expectations, non-tradables inflation was higher than the RBNZ had forecast, and that will raise questions on how persistent price pressures will be in the next few quarters. The widespread nature of pricing pressures should see some short-term upward adjustment to the inflation outlook.
While the RBNZ’s baseline outlook may not have changed much, both upside and downside inflation risks have become more pronounced since the May Statement (as shown in this week’s Chart of the week).
On the downside the focus should be on the weakness in China and commodities markets, along with the related possibility of a steeper downturn in the economy and an earlier move lower in inflation. A May 2024 easing could come into focus in that scenario.
On the upside, greater persistence in domestic inflation, stronger house prices, and a slower adjustment in the labour market would confirm Westpac’s view that a hike in the OCR will be back on the table by the time of the RBNZ’s November OCR decision and Statement.
Ahead of the RBNZ’s meeting, there will be some interest in the REINZ housing report for July and migration data for June. In recent months house sales have moved decisively off their cycle lows and house prices have edged higher – developments that will no doubt have caught the attention of the RBNZ. Very strong net migrant inflows earlier this year have probably contributed to this uplift, so we will be interested to see whether the recent moderation in inflows has continued in June. On Wednesday the results of the latest GDT auction will likely be awaited with some trepidation, especially after the very sharp fall in whole milk powder prices at the last auction. Indeed, given the weakness in recent auction results, and following Fonterra’s own forecast revision, we have this week further revised down our forecast for the 2023/24 farmgate milk price to $7.50kg – a level that will likely leave many farmers in the red for the season. The June quarter business price indexes close out the week’s dataflow on Thursday. While not a big focus for markets, the producer price indexes might cast some light on the inflation pipeline.
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