Weekly Economic Commentary 27 November 2023
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
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Times of change: A new government and prospects for lower rates.
The RBNZ will almost certainly leave the OCR unchanged this week. But the key interest is in what they have to say about the outlook and whether market expectations of rate cuts in 2024 will be validated. We expect they will be keen to push back on rate cut expectations as there is likely a lot of water to go under the bridge before those become a reality. A new government has been formed with the final coalition agreement delivering a policy package that is just a touch more contractionary than National campaigned on.
Market expectations for interest rates have swung around wildly in recent months. Two months ago, the higher for longer mantra was all the rage and long-term interest rates were rising fast and markets had priced a good chance of further OCR rises into the curve for 2024. More recently the tide has turned, and markets have now priced a decent chance of an OCR cut in May 2024.
The dataflow recently has supported the markets move towards pricing in easings next year although we think there is quite a bit of water to go under the bridge for those easings to become a reality. There is clear evidence of a cyclical downturn in growth (although last week’s flat retail trade outcome for the September quarter was the best outcome we have seen for some time). But there’s a lot of work to do to bring core inflation back to the levels consistent with the 1-3% target range. And the clear message of the incoming government is that they expect the RBNZ to be firmly and solely focused on price stability.
Hence the key focus this week is on what the RBNZ has to say about the outlook for interest rates. We suspect they will be reluctant to validate market expectations for easing any time soon and hence they will deliver a forward track for the OCR that is little changed from the one projected in the August Monetary Policy Statement (MPS). We think it will suggest that interest rates will remain unchanged for much if not all of 2024. We think that dovish talk of rate cuts will need to wait for the time when the RBNZ is sure that inflation will be inside the target range within about six months and when they have confidence it will stay there. They likely don’t have that confidence now given that, so far, quarterly core inflation measures are sitting 0.5-1% above the levels seen over the 1995-2019 period. Rather we suspect that even if the stars align, the evidence to support a rate cut won’t be available until the August 2024 MPS at the earliest.
The other big change is the forming of a new government. Given the overlapping policies in the parties' respective manifestos, as expected the final policy mix included in the coalition agreements had few surprises. National’s tax cuts will be delivered as promised but will be funded differently from that campaigned on as the foreign home buyers’ tax hasn’t survived the negotiations. The government has found other cost savings and revenue initiatives to cover the costs of the tax cuts (for example by not increasing the Working for Families tax credit in 2026, changes to tobacco legislation and by delaying when tertiary students are eligible for a year of fees-free tuition – the latter reducing costs, as up to a third of students fail to complete their degree). Therefore, the new Government’s overall fiscal policy stance, at least as regards the operating balance, appears likely to be moderately more contractionary than that which the outgoing government would have pursued. That said, we continue to think that some elements of the new government’s programme – notably its policies that will encourage more investor participation in the housing market – will provide some offsetting stimulus to the economy.
On balance, the details of the coalition agreement announcement do not appear to call for any reassessment of our outlook for the economy, the RBNZ’s monetary policy stance or the Crown debt programme.
Cabinet ministers will be sworn in today and the new Parliament will sit on 5 December. Parliament will likely sit under urgency to pass key legislation required to give effect to some of the items on the Government’s “100-day plan”. Given the extensive work programme of the new Government, the Prime Minister has indicated that the House will sit right up until Christmas and will probably resume shortly thereafter following a briefer holiday adjournment than would normally be the case.
In the near term, a key focus will be the production of the foreshadowed “mini-Budget” which the incoming Minister of Finance has indicated will be published alongside the regular Half-Year Economic and Fiscal Update (HYEFU) sometime in December (this must be tabled before the House adjourns for the year, which will likely be on 21 December). In addition to providing the usual update on how the changes in the economic outlook since the Pre-Election Economic and Fiscal Update (PREFU) have impacted the fiscal outlook, we expect the HYEFU will give some indication of the Treasury’s estimate of the financial impact of the Government’s most important policy initiatives (such as the tax and spending cut programme). The implications of the remainder of the Government’s programme will be set out in Budget 2024, which will likely be tabled in May as usual.
Something that will be of interest to markets is the implementation of the new government’s intention to change the RBNZ’s mandate to focus on inflation solely. The government sees this as a pressing priority, raising the question on how this will be achieved. Practically, this will require an adjustment of the RBNZ’s Remit (which currently refers to two objectives, price stability and maximum sustainable employment). It may be possible to give effect to the new Government’s policy with a new Remit (which doesn’t require legislation), by reducing the importance of the employment objective in some way. But ultimately a more permanent and robust change to the RBNZ Act will be required (Sections 9 and 117).
Finally, last week I travelled the country and presented our current economic forecasts to customers and took the opportunity to survey their views on the economic outlook. Interestingly, there was a broad consensus that, notwithstanding some of the dour economic news of late, the economy is not going to record a recession this year. Customers in Christchurch and Auckland were particularly positive which is perhaps understandable given the importance of tourism to the Canterbury economy and migration to Auckland.
Customers saw tangible signs that the labour market is easing, and that wage growth will be slower. Indeed, customers overwhelmingly see wage growth decelerating from current levels – a departure from the scepticism that was evident when we conducted the same exercise in August.
Consistent with formal business surveys, customers are more pessimistic than most forecasters and the RBNZ on when inflation will return to the target range. A sizeable majority of people saw the return to the target range coming in the second half of 2025 or even later. The RBNZ has consistently seen this occurring in the September quarter of 2024. So, we have a gap to bridge there!
Customers seemed to have a more mixed view of the exchange rate – although most centres seemed more upbeat about prospects for the NZD/USD compared to when I asked this question in August. Wellington customers seem the most pessimistic on this score (and indeed more generally).
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