There’s one number that stands out to me from the Reserve Bank’s OCR announcement yesterday.
In fact, I’d go so far as to say that the extent of the economic pain Kiwi businesses and households will have to endure over the next six to 12 months rests entirely on this statistic.
The figure I’m talking about is hidden deep in the 60-page document (the Monetary Policy Statement, or MPS) released summarising the thinking behind the decision...
It’s the RBNZ’s forecast for September 2024 quarter inflation: 1.3%.
As the chart shows, the number is an outlier amongst a run of actual and forecasted quarterly CPI results all sitting at, or near, 0.5%.
It’s what’s holding forecasted annual inflation well above the mid-point of the RBNZ’s 1% to 3% inflation target band – and is why the RBNZ is forecasting there will be no reductions to the OCR until sometime in 2025.
Having read the MPS cover to cover, the main themes that stand out for me are:
- Most economic indicators have been weaker than expected over the last three months.
- Non-tradeables inflation is the ‘problem child’ and needs to be dramatically reduced from the current level of around 6%.
- Tradeables inflation is forecasted to increase slightly, due to a resilient global economy, but nevertheless remains close to 0% as it has for much of the last two decades.
- The Official Cash Rate is expected to remain as is until mid-2025. Even so, monetary conditions will tighten further as the delayed effect of OCR hikes continues flow through to consumers as they roll onto higher fixed mortgage rates, peaking at around 6.5% on average.
- This will constrain economic activity in NZ, with GDP growth expected to be anaemic over the course of 2024 at 1% (after negative GDP growth in four of the last five reported quarters).
- Productivity is declining as the population grows through migration, but output stagnates.
- A good chunk of inflation comes from factors that aren’t much influenced by monetary conditions – i.e. local body rates, insurance premiums and rents.
Of note, the RBNZ offers no explanation of the ‘outlier’ September 2024 quarter CPI forecast.
So, why is the RBNZ’s forecasted inflation for the September quarter so high? Delving into the historical data sheds a little light.
Over the last three years, September quarter CPI has – consistently – been much higher than in other quarters.
There are two unique factors which largely drive this trend: annual local body rate increases coming into effect starting from July, and the seasonal price peak in fruits and vegetables that happens over winter.
But even taking these forces into account, plus continued insurance and rent increases, the RBNZ’s forecasted CPI of 1.3% (on which ongoing tight monetary policy is predicated) feels unreasonably high.
By my calculation, it would take other prices rising significantly during the September 2024 quarter — with limited offsets from falling prices in other categories — for this to be the case. Whilst this seems unlikely to me, it’s nevertheless the Reserve Bank’s forecast.
What does this mean for interest rates?
In a nutshell, watch and wait.
The September quarter CPI will be released in mid-October. The first OCR review after this is on the 27th of November, so unless the RBNZ dramatically lowers its forecast for the CPI that quarter, it’s likely OCR will be on hold until at least that date.
If leading indicators show that the CPI might be lower that quarter, wholesale markets will start to anticipate an OCR cut, and that may result in lower fixed-term mortgage rates ahead of any changes to the OCR.
But with the Reserve Bank still on a mission to stamp out inflation – adamant that the job isn’t done yet – I wouldn’t be holding my breath for an OCR cut.
And if you think the economy is weak today, the news isn’t good. There’s a lot more pain ahead. I wouldn’t be surprised to see New Zealand remain in recession for much of 2024. Which is exactly what Reserve Bank Governor Orr said he’d deliver.
Footnote:
The wholesale markets, for one, aren’t putting a whole lot of stock in the RBNZ’s commentary, or plan of action for the OCR. Currently market pricing – shown in the graph below – has the OCR down to 4.5% in a year’s time (1% below the RBNZ forecast), with cuts starting from November 2024.
