Weekly Economic Commentary 4 December 2023
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
Read full report here (PDF 681KB)
Now is not the time for rate cuts
The RBNZ poured ice water over the emerging market trend to price in OCR cuts in 2024. Rather, the RBNZ lifted their forecasts for interest rates reflecting increased concern on the demand impact of strong net migration, sticky core inflation and the future fiscal stance. RBNZ meetings next year are now live in terms of the potential for increased interest rates. Data on core inflation, growth, migration, house prices and the future fiscal stance will be key in determining if the OCR remains at 5.5% or rises further in 2024.
As widely expected, the RBNZ left the OCR at 5.5% at its final policy review for this year. Of much greater interest to markets was what the Bank had to say about the outlook for the OCR next year and beyond.
The updated projections in the accompanying Monetary Policy Statement (MPS) contained significant revisions from those published back in August. A key change is that the RBNZ’s projections reflect a heightened risk that a further 25bp OCR hike will be required in 2024. The probability of a further 25bp hike in 2024 is now estimated at around 75% compared with 36% previously (the peak OCR increased to 5.69% from 5.59% previously). Thereafter, the RBNZ’s projections imply a modest easing cycle from mid-2025 – much later than implied by current market pricing. The RBNZ’s revised OCR track now closely resembles our own – albeit with the tightening coming around 6 months later.
The key drivers of the more heightened perceptions of inflation risk stem from a reassessment of the medium-term impact of very strong migration driven population growth. In addition, the RBNZ has become more cautious on the pace to which they expect core inflation pressures to moderate. That reassessment is reflected in a stronger housing market (and rents) profile, stronger near-term growth, and lower unemployment forecasts and a higher profile for government investment in the infrastructure required to support a growing population.
The bottom line is an upwards revision to the RBNZ’s medium term inflation forecasts (from mid-2024 onwards) even with higher interest rates. On top of this, the RBNZ notes an asymmetric risk profile around medium-term inflation outcomes – with upside risks there.
The RBNZ seems more focused on ensuring that inflation hits the middle of the target range in the next 18 months to 2 years. Hence, given still persistent core inflation, strong population growth and an upwardly revised long-run neutral OCR (increased a further 25bp to 2.5%) the clear message is the balance of risks has shifted towards a need for further tightening. And certainly, there is reduced tolerance for upside surprises to inflation – which is also consistent with the new government’s objectives when the new Monetary Policy Committee Remit (and new RBNZ Act) is promulgated.
The upshot is that we retain our view that the OCR will be increased by 25bps at the February MPS. The RBNZ’s message and core concerns now map more closely to our own. The relatively high probability of a hike in Q3 2024 indicates that all meetings from now should be considered “live”. The Governor noted, the RBNZ is now “willing” to act if needed.
We think there are two key messages to take from the RBNZ news this week. Firstly, the market is on notice that policy easings are very unlikely for the foreseeable future. Easings are going to need to be motivated by a much weaker run of data on future core inflation pressures, and housing market trends. Our recent note on what it will take for rate cuts to become reality still seems very relevant. Secondly, a message for the new Government is that the fiscal stance needs to be noticeably tighter than was embodied in the Pre-Election Economic and Fiscal Update (PREFU). The new Government’s fiscal plans in the forthcoming Half-Year Economic and Fiscal Update (HYEFU) need to reflect a tight stance to avert the need for a higher OCR.
There is still plenty of water to flow under the bridge ahead of the February 2024 MPS and so it’s possible a hike in the OCR comes later than February (or not at all). We will be watching the following key data and events:
- The Q3 GDP report on 14 December. Next week will see some key partial indicators of Q3 GDP. We currently expect modestly weaker growth than the 0.3% factored by the RBNZ. The tone of that report (and the interpretation of downward revisions to historical data already foreshadowed by Stats NZ) will be important.
- Migration data and all housing-related data. The RBNZ’s concern about the impact of migrant inflows on domestic demand, including via the housing market, which makes data on migrant inflows, housing turnover, house prices and dwelling rentals over coming months critical.
- The HYEFU. The new fiscal stance (and other policy changes) will be factored into the RBNZ’s February Statement. The updated estimated “fiscal impulse” and analysis of other new policies (investor housing) will be very important.
- The Q4 CPI report on 24 January and preceding monthly updates. Non-tradables inflation will be key. We currently forecast the Q4 outcome to be slightly below the RBNZ’s updated forecast, but the data needs to confirm a significant step-down in core inflation indicators (see chart).
- The Q4 labour market surveys on 7 February. These Labour market indicators were downplayed by the RBNZ this week and our forecasts for Q4 don’t materially differ to the RBNZ’s. But we are sure that wages and unemployment rate trends will ultimately matter.
Data last week was a bit of a mixed bag for the RBNZ. There was some welcome reduction in inflation expectations in the ANZ business confidence survey while activity indicators continued to improve a touch and pricing expectations outside of retail looked quite sticky. Building consents bounced a solid 8.7% in October but we think that’s more volatility as opposed to changing the underlying weak trend.
A final note on forthcoming changes to the RBNZ’s Remit and Act to focus the RBNZ solely on inflation control. We don’t think that these adjustments will do much for the conduct of policy in most circumstances. Perhaps an exception would be the case of supply shocks which might temporarily boost inflation. However, in the current context we think these adjustments will affect the RBNZ’s assessment of the balance of risks for policy in the next year or so. The government is sending the RBNZ a clear message that inflation needs to be its highest priority and there is no room to be taking chances that might cause inflation to remain well above 2% in mid-2025. Hence, we think the upshot is that we should expect the RBNZ to be unforgiving of any shocks that boost the growth and inflation outlook over the next year. Also, the RBNZ will likely be less willing to pre-emptively ease, as markets seem to currently expect. A pre-emptive easing that turned out to be the wrong judgement would not be greeted warmly by the Minister given the new Remit.
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