Too little, too late
OPINION: Economists, in their usual excitable tones, have, for a while now, been openly questioning the Reserve Bank’s glacially slow reaction to the recessionary economic conditions we’re all drowning in.
“We have come through this period where the market was very constrained by the effects of the COVID -19 pandemic,” says Rabobank Senior Market Strategist Ben Picton. “The supply side was under a lot of pressure; demand was being juiced up by very low interest rates and lots of government spending. Now the economy is rebalancing.”
The bank’s view is the Official Cash Rate (OCR) has peaked at 5.5% and two rate cuts will be delivered by the Reserve Bank of New Zealand (RBNZ) in the second half of 2024. A key factor in this view is the recent slump in New Zealand economic activity, with a technical recession in early 2023 and third quarter contraction.
“We expect that when we get the data for the last three months of 2023 it could show another contraction,” says Picton. “This has helped to bring headline inflation down rapidly, [as] year-on-year inflation fell to 4.7% at the end of 2023 and fourth quarter inflation of just 0.5% was very encouraging. However, there is still some way to go to reach the midpoint of the RBNZ’s 1 to 3% target range.”
Higher unemployment also supported the bank’s view, despite recent data highlighting the labour market was responding to tightening monetary policy slower than expected.
“What that indicates is that the labour market is a lot more resilient than what economists had been predicting. A tighter labour market means higher wages growth and aggregate demand. Right now, the RBNZ will be a little concerned about this, but there is softness beneath the headline figure, and overall we think unemployment will rise at a fast enough rate to support our view.”
An additional factor supporting the bank’s interest rate expectation was the significant time lag associated with monetary policy cuts. Picton explains that it can take a full two years for the full impacts of rate increases to take effect, so only now are we starting to feel the full effects of the first rate hikes from late 2021 and early 2022.
In addition to a resilient labour market, Rabobank identified accelerating consumer spending and the Red Sea conflict as further threats to the bank’s forecast.
“For a small open trading economy like New Zealand that imports a lot of goods from the rest of the world, inflationary pressures on internationally-traded goods is potentially a risk to the trajectory of inflation in New Zealand that might delay rate cuts.”
Looking beyond 2024, Rabobank anticipates the OCR would eventually settle at around 3.5%.
“The RBNZ gives us a bit of an idea about where they think interest rates will settle in the long term because they publish their expectations of what they call the neutral rate, which is the rate at which they think that interest rates are not adding to inflation or subtracting from inflation,” said Picton.
“Now, they think that the neutral rate is 2.5%. With a 2.5% OCR, inflation won't be accelerating or decelerating. We think that that is maybe a little bit too optimistic and is based off recent history, but we've seen changes in the structure of the global economy which maybe suggests that neutral rates are actually higher than what they used to be.
“We think it's probably closer to 3.5% than 2.5%. And that’s a roundabout way of saying, in a nutshell, we think that the OCR converges on 3.5% sometime in early 2026.”
