Weekly Economic Commentary 9 October 2023
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
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High for longer; probably still higher too.
The RBNZ left the OCR at 5.5%. The forward view espoused was less hawkish than anticipated but affirmed that they are not expecting to lower the OCR for a protracted period. While they recognise some stronger indicators of late, they expect higher long term interest rates and an easing of the labour market and economic growth to eventually bring inflation down. We remain less convinced and have revised our forward profile for the OCR to reflect the ‛higher for longer’ message coming from the data, markets and to some extent the RBNZ.
It was a very busy week for the economy and markets that culminated in a much-watched RBNZ Monetary Policy Review that surprised a market expecting a more hawkish stance. The RBNZ still sees risks that there is a chance that the economy doesn’t slow as much as required to bring inflation down or that inflation itself proves more persistent than hoped. But these risks are balanced in their eyes by the significant increase in long-term interest rates we discussed in last week’s “chart of the week” and the slew of cyclical demand and labour market indicators that suggest a slowdown in growth in the second half of 2023 and an easing labour market.
Risks to wage growth remain a key consideration for the RBNZ. On that front, we saw in last week’s Quarterly Survey of Business Opinion (QSBO) showed signs of easing conditions as the inflow of migrants is being integrated into an economy still in need of labour.
The bottom line for the RBNZ is that they think they can stand pat – potentially for quite a long time – and let past tightening do the work. Buried deeply in the MPR minutes was some sign that the recent data (for example strong H1 2023 GDP, stronger house prices, the recent bounce-back in dairy prices) had raised the risks a bit. But rather than pushing the RBNZ towards additional hikes in the short term, the response to those developments for now is has been to push out the time when easing might be contemplated, with the Monetary Policy Committee noting that “interest rates may need to remain at a restrictive level for a more sustained period of time”. The RBNZ’s August interest rate projections didn’t show rate reduction until late 2024. But based on the updated comments in the MPR, we suspect that the RBNZ now isn’t contemplating cuts until sometime in 2025.
Our view on this is that we are not convinced that enough has been done – so in terms of inflation risks we think the OCR increase ball is still in play – but we can certainly see the MPC’s reaction function quite clearly. It’s a hurdle to get the MPC to move and the upcoming September quarter CPI and labour market data due in the next few weeks will be critical in seeing if we can get the required movement there. Hence, we still see an increase in the OCR at the November Statement – contingent on a strong set of core inflation and labour market outcomes in the next few weeks.
Further out though, we have made changes to our forward view. We have been running with the idea that the RBNZ would respond to building inflation pressures relatively quickly, thus bringing inflation down faster and allowing for earlier interest rate cuts. This is not the MPC’s revealed reaction function now. Hence, we are responding to this information by revising up our future profile for the OCR and hence longer-term interest rates. We now don’t see an easing in 2024 – we think this could come in early 2025 – and hence our forecasts for longer term rates are now higher.
Our updated interest rate profile is much more consistent with the message coming from the data but especially the financial markets which have sharply revised up interest rate expectations globally. This information might reflect many things (animal spirits, debt supply, risk premia) that could be tightening financial conditions even though the growth and inflation outlook is weak. Alternatively, it could reflect the view that recession risks are receding, or that inflation pressures are more persistent. That inflation persistence message is the one that resonates most clearly to us.
A lot of things have changed since the RBNZ charted their course to push the OCR to 5.5 % in late 2022. Key issues have been an entirely unanticipated migration boom that is taking population growth to levels not seen since the 1960’s and a marked turnaround in the fiscal stance in 2023/24 from one where fiscal policy could have helped the RBNZ to reduce growth and inflation pressures to one where the fiscal stance is frustrating those goals.
As a result, since 2022 the RBNZ’s growth forecasts have been significantly revised up and unemployment rate forecasts revised down, while the RBNZ’s inflation forecasts have remained well anchored around the idea that inflation will return to the 1-3 % target range by end 2024. The RBNZ’s assumptions might prove correct (for example if the growth potential of the economy has increased significantly with population growth), or indeed another negative shock hits us and drives the economy and inflation down (for example an extension of the fall in the terms of trade seen this year as the Chinese economic outlook has weakened). However, we are concerned that inflation might persist and that the RBNZ’s interest rate strategy may not have been sufficiently adjusted to accommodate these factors. It may be that an OCR of 5.5% is insufficient to bring inflation down fast enough without risking a rise in inflation expectations, which could compound upward pressures on costs and wages. Households and businesses might not see much respite from the pressures they have been under for a while now in that scenario.
Either way, it looks like we should be prepared for interest rates that are either higher for longer or high for longer. The data will tell us which of those outcomes we see.
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