In a nutshell:
- The Reserve Bank is due to make its first OCR announcement of 2023 on Wednesday 22nd February.
- Its last announcement in November left us reeling with a record 0.75% increase, and the admission that it was forcing us into a recession to bring inflation under control.
- Signs are good that's starting to happen, but the OCR will need to keep going up for a while yet to ensure we finish the job.
- The challenge for the RBNZ this time is getting it just right - not too hot (creating a hard landing) and not too cold (undoing the progress we've already made in the battle against inflation).
- On 22nd February, will Governor Orr go for 0.75%, 0.50% or 0.25%?
The summer break brought a welcome reprieve from a year of relentless OCR increases, but that’s all coming to an end with the Reserve Bank’s (RBNZ) first announcement of 2023 on Wednesday 22nd February.
A little reminder, if anyone’s managed to forget, the RBNZ’s last announcement saw Governor Orr hit us with a massive and unprecedented 0.75% increase, taking the OCR up to 4.25%.
But even more than the numbers, it was probably the words he chose in making the announcement that scared Kiwi the most. It was an admission that he, and the Reserve Bank, was willing to do whatever it took to get inflation under control, even if that meant tipping New Zealand into recession.
After hearing that sort of narrative, it felt pretty inevitable that we were in for another 0.75% increase this time round – but a lot’s happened in the two and half months since late November.
There’s no doubt that we’re in for another increase, but the question is how big will it be?
So, what’s changed since the end of last year?
The latest stats, released towards the end of January, show annual inflation has remained steady at 7.2%. That’s good news, because what it tells us is that inflation has likely peaked and decreased in the last quarter.
Construction is one area which has been a really major contributor to inflation, with all those climbing costs that made headlines last year. But the sector’s been left bloodied and bruised in the last few months, with the bottom having largely fallen out of the residential construction market. Soon, the industry will be left crying out for work, and any inflation will disappear.
On the unemployment front, we’re starting to see evidence of companies restructuring and cutting jobs – Sharesies, Mediaworks – and you’re going to see a whole lot more of that moving forward. Most recent figures show employment levels haven’t really moved in the last quarter, but it’s pretty obvious that we’ll start to see an increase in the unemployment rate over the coming weeks and months.
We’re not seeing the same level of wage pressure that was in place for most of last year, so it seems like we’ve dodged the bullet of any sort of wage price spiral.
In other words, the sense is that the market has turned, and businesses are starting to respond to that.
The recent flooding throughout the upper North Island, and the immense damage that’s been sustained, is another factor that needs to be considered. You could argue the floods will have an inflationary effect (which would only be transitory) but there are huge parts of the population who have been left facing genuine, added hardship as a result of what’s happened.
Consumer confidence is the lowest it’s ever been, although restaurants and cafes are still pretty busy. So, there are some mixed messages there, but as more people head for fixed rate rollovers, and the impact of mortgage rate increases becomes more widely felt, that’ll start to change too.
To sum up – while there will be some upside risks with inflation, overall, you’d say signs are pointing to the fact that things are starting to come under control.
So, where’s the Governor’s thinking likely to be at now?
Will he feel he needs to keep making aggressive OCR moves until the economy is left bleeding, and people are on their knees?
Or will he look at all that data suggesting things are coming under control, and go for a more pared back approach, especially with large parts of the mortgage market repricing on to significantly higher rates in 2023?
As I see it, there are three possibilities for how things could go on February 22nd – some much more likely than others. Let’s take a look at the thinking behind each.
The case for another 0.75% increase.
In the immediate wake of November 23rd, bank economists were pretty unanimous in the view that we were heading straight for another 0.75% increase this time round.
I was one of very few dissenting voices at the time, simply because I could already see the harm flowing through to customers thanks to previous hikes. It took a while for the impact to show up in the Reserve Bank’s data (which it is now), but for us, being on the front line dealing with Kiwi mortgage borrowers, it was plain to see the impact flowing through mid to late last year.
The Reserve Bank considers a “neutral” OCR (one that neither stimulates nor depresses the economy) to be somewhere in the realms of 2.00% - 2.50%. It’s probably closer to 2.50% given there’s likely to be more inflation going forward for a whole raft of reasons.
That means “neutral” mortgage rates sit at around 4.50%. And we’re running at 6.50% at the moment – way above neutral.
The fact is we’re squeezing homeowners extremely hard already. Throw in a slowing economy, rising costs, and the impact of things like the North Island floods, and there’s no doubt in my mind that we’re heading for a recession.
And that’s ok, because recessions are a fact of life, and we’ll recover.
But if the Reserve Bank does go for another triple hike, that would see mortgage rates increase yet again, and that would be brutal.
So yes, 0.75% might have been the market consensus at the end of last year, but a lot’s changed since then. I’d be shocked if Governor Orr opted for another 0.75% increase this time round. And it’d be very real (and unwelcome) surprise if this was the outcome on February 22nd.
The case for a 0.50% increase.
Even though signs are good that inflation is starting to come under control, the tough truth of it is that the OCR will need to keep going up for a little while yet to make sure the job’s done properly.
If the Reserve Bank went too easy with this next announcement, we’d start to see mortgage rates fall again, because the market’s already priced in another 0.50%. And the last thing we need is for rates to fall too early, and undo the progress that’s been made.
So, to me, opting for 0.50% sends the message that things need to stay tight, without feeling like a real “oh crap” moment, where we’re at risk of taking things too far.
In terms of fixed mortgage rates, if we get a 0.50% increase, things should stay pretty much where they are. In other words, it would indicate we’re at peak rates.
This middle ground approach is what most of the market is now anticipating will happen, and that’s why we’ve seen longer-term mortgage rates starting to drop in recent weeks.
If 0.50% is what we get on February 22nd, that would suggest that the OCR could peak lower than the most recent Reserve Bank forecast of 5.50%. It will likely have another 0.25% to 0.50% to go before topping out around middle of the year.
The case for a 0.25% increase.
Given all the headwinds we’re seeing out there, and the gnarly impact those are having on consumers, there’s a small part of me that says Governor Orr could opt for a more pared back, measured approach for this next announcement.
OCR announcements roll around every six weeks, so there’s plenty of opportunity to hike rates without needing to do it in big hits. This would give the Reserve Bank the chance to just get a better grasp on the full effect of the changes that have already come through, which I think are currently being underestimated.
For example, there’s still a massive part of the market due to roll off low fixed rates in the next 2-3 months, so the damage caused by previous rate increases would continue to grow, even if the Reserve Bank did nothing.
So, it’s still an increase, yes, but a 0.25% increase would mean that fixed rates should come back ever so slightly, and would ultimately mean that the OCR should peak somewhere around 5.00%.
What’s the most likely outcome?
If I were the boss (which I’m clearly not) I’d run with a 0.25% increase. The signs are all there that people are being hit, hard – and I’m convinced we’re already on track for a recession.
But while it’s easy for those of us on the outside to offer up opinions about the “right” course of action, the fact is the RBNZ has a bloody tough gig.
Go too low and the inflation hawks will accuse you of being soft, and say you’ve got to do more to bring inflation under control. And if time shows that 0.25% wasn’t enough to do it, you carry the blame.
On the flip side, go too hard with 0.75%, and you end up being directly responsible for creating the sort of “hard landing” for the economy that none of us want.
The Reserve Bank can’t afford to get it wrong. So, to me, a 0.50% increase feels like it has the highest probability of being just right this time round – not too hot, not too cold. It’s the Goldilocks zone.
After that, my view is that we could be in for another one or two 0.25% increases, with the OCR peaking at 5.00% or 5.25%.
Whatever’s coming, we’ll find out on February 22nd.