BNZ economists are warning of "the increasing likelihood" of a global recession and say the Reserve Bank (RBNZ) should do nothing to suggest it has raised its view on how high the Official Cash Rate might get.
The RBNZ is due to have another OCR review on October 5, and in a preview of this in the BNZ's latest Markets Outlook publication, BNZ head of research Stephen Toplis says it is difficult to see why the RBNZ would be convinced the medium-term risk to inflation is sufficiently high to demand a substantial shift in its rate view.
At the moment the OCR is at 3.00%, having been hiked aggressively in the past year from just 0.25% as of the start of October 2021 and in response to surging (7.3% as of the June quarter) inflation. The universal expectation is that the RBNZ will hike the OCR to 3.5% on October 5 and then to 4.00% on November 23, the last review for this year.
The RBNZ as of its August Monetary Policy Statement forecast a peak OCR by the middle of next year of a little over 4%, but it has since publicly indicated that 4.25% is at least possible. However, market pricing is now getting a long way ahead of this, and ANZ economists are forecasting a peak of 4.75%. Fixed mortgage rates, which had been falling, are now rising again.
Toplis says "taking into consideration the balance of risks", the BNZ economists have formally introduced a further 25 basis point rate hike into their OCR forecast track for the February RBNZ meeting, taking the OCR to 4.25% at that time.
"The cash rate stays at this level through 2023 before progressively moving back towards a neutral rate [neither stimulatory, nor restrictive], which we have lifted to 2.25%," Toplis said.
"The risk around these forecasts is balanced."
He said "the hawkish scenario" is the falling Kiwi currency drives inflation higher than anticipated for longer "but the downside is a crippled global economy".
"We can’t stress enough our fear that the rapidity of rate increases globally, coupled with the disastrous consequences of Europe/UK’s energy crisis, means things could well and truly turn to custard."
Indeed, Toplis said the way things are going it’s increasingly looking like a “when” not an “if”.
"When it becomes clear central banks have “over-tightened” there will be a rush to forecast rate cuts. The higher rates go now the bigger will be the reversal."
Toplis believes the RBNZ will be well aware of these risks and will, ideally like to buy itself time.
"It does not publish a rate track within a Monetary Policy Review. We doubt it will formalise a more aggressive stance in the text of its statement, certainly not one which would encourage fixed interest markets to sell off any further but in reiterating its August stance it might offer some suggestion that current pricing is a tad overdone. Given New Zealand’s leverage to global demand it tends to suffer more than most during downturns. The RBNZ will not want to exacerbate that process."
However, the "big unknown" is how does the RBNZ think it should respond to the recent "surprising aggressiveness" of the US Federal Reserve?
"The Fed is now suggesting the US cash rate could move into a 4.50% to 4.75% band. Was this the case it would make it harder for the RBNZ to keep its cash rate peak near 4.00%, as specified in the August MPS. Were it to do so this would put even greater downward pressure on the NZD especially given that the NZ market is currently pricing in a 4.8% terminal cash rate," Toplis said.
"At this juncture, it is difficult to see why the RBNZ would be convinced the medium-term risk to inflation is sufficiently high to demand a substantial shift in its rate view.
"There are, nonetheless, developments that the Reserve Bank will be very wary of. To start with, global inflation has nudged higher than anticipated and forecast inflation for calendar 2023 has increased. Importantly for New Zealand is that these upward revisions are being accompanied by a currency that continues to depreciate.
"At the time of writing the NZD Trade Weighted Index was sitting at 67.5. This is 5.9% below where the RBNZ had assumed it would sit. If it stays here that could add as much as 0.6% to CPI forecasts, which is clearly unhelpful."
Toplis said an argument made by some is that recent downward pressure on mortgage interest rates will be annoying the RBNZ so it will have to tighten more to get the same impact.
"We are not so sure. We would be concerned if current mortgage lending rates were resulting in a spike in lending to households but this is clearly not the case.
"To the contrary, growth in lending to households continues to fall. Moreover, we assume that once the Funding for Lending Programme [lending for banks from the RBNZ priced at the OCR level - due to end in December] stops providing cheap funding to banks, at the end of this year, mortgage rates will come under further upward pressure.
"This will be accompanied by increased competition for term deposits. The RBNZ acknowledges this will put upward pressure on rates. The big question is how much? We really don’t know. But were spreads between mortgage rates and wholesale rates to return to “normal” levels then this could have the same impact on monetary conditions as at least 50 basis points of rate hikes."
Posing the question of whether the RBNZ could eventually deliver a series of further rate hikes in 2023, Toplis said - "absolutely".
"But we think it is too early for it to feel comfortable making this its central scenario now. For this to happen the Bank’s view on future inflationary pressures needs to be revised higher which, in turn, would probably require it to believe the labour market remains tighter than previously thought as well."
On the international picture, Toplis said global inflation may be rising but this is heavily concentrated in the Eurozone where the Russian invasion of Ukraine continues to result in devastating increases in energy prices.
"While this is problematic for inflation, it is even more problematic for growth with expectations for economic activity being revised much lower on the back of the resulting disposable income hit, which is being accompanied by aggressive central bank responses as they seek to prevent a 1970s style wage-price spiral.
"Outside of the Eurozone, growth forecasts are also being lowered.
"It has been a very long time since the world has witnessed such a synchronised tightening cycle.
"In our opinion, folk are now underestimating the likelihood of a global recession. And even the optimists concur that growth will fall below average such that spare capacity will start to develop. This being so, the medium-term pressure on global inflation must be sharply downward.
"The RBNZ can’t ignore this. Indeed, it is conceivable that when the RBNZ convenes in February, to decide whether or not to push its cash rate above 4.0%, that it is staring down the barrel of a global recession."
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