Reserve Bank leaves Official Cash Rate unchanged at 5.50% but says interest rates need to remain at a restrictive level for some time

The Reserve Bank (RBNZ) has again left the Official Cash Rate (OCR) unchanged on 5.5%.

It's the second consecutive 'on hold' decision from the RBNZ since it indicated in May it was done with raising rates, at least in the foreseeable future.

The overall tone of the statement put out on Wednesday by the RBNZ was similar to its two most recent ones and the key signoff last paragraph was very much the same, namely: "The Committee is confident that with interest rates remaining at a restrictive level for some time, consumer price inflation will return to within its target range of 1 to 3% per annum, while supporting maximum sustainable employment."

In its latest Monetary Policy Statement, also released on Wednesday, the RBNZ has issued new forecasts - and these show a slightly longer timeframe for the OCR to be cut again than the previous forecasts in May. And also, the RBNZ is leaving its options open of another increase to the OCR by now having a 'peak' OCR in its forecast track of 5.6%. (In reality the RBNZ would not increase the OCR to 5.6%, but putting that figure in indicates that a future hike is a possibility - in which case it would likely be to 5.75%) It now doesn't see the OCR starting to be cut till the last quarter of 2024, which is three months later than it forecast back in May.

ASB senior economist Mark Smith said the RBNZ was wary over declaring victory over inflation too soon "and has flagged the risk of the OCR moving higher-still, with the published rate track tweaked up".

"...We still view there to be a high hurdle to OCR moves.  We remain comfortable that 5.50% will be the OCR peak in this cycle but note some risk of more monetary restraint being necessary if domestic inflation readings fail to quickly subside."

In its latest forecasts the RBNZ still sees inflation getting back into its target 1% to 3% range in the second half of next year.

It has eased back a little on its unemployment forecasts. Previously it forecast unemployment to hit 4.1% by the end of the September quarter. Now it sees a 3.8% rate. Actual unemployment was 3.6% as at the end of June. The RBNZ's now forecasting unemployment of 4.4% by the end of this year, down from a previous forecast of 4.6%.

The RBNZ's forecasting that GDP, after shrinking in the December 2022 and March 2023 quarters will have grown again in the June quarter, but will then shrink in both the September and December quarters of this year. That's a slightly more downbeat forecast of GDP's prospects than was contained in the May forecasts. Two consecutive quarters of a shrinking GDP is 'technically' a recession. 

Governor Adrian Orr said in the near term, there is a risk that activity and inflation measures do not slow as much as expected.

"Over the medium-term, a greater slowdown in global economic demand, particularly in China, could weigh more on commodity prices and overall New Zealand export revenue."

Between October 2021 and May 2023 the RBNZ increased the OCR at unprecedented speed, making 12 consecutive hikes that took the OCR from the pandemic emergency setting of 0.25% all the way to 5.5%. Then it signalled in May, through its forecast that it was done with the hikes - at least in the foreseeable future.

This rapid raising of interest rates was in response to a soaring inflation rate, which, as measured by the Consumers Price Index, hit a 32-year high of 7.3% in mid-2022 and has fallen only slowly, down to 6.0% as of the June quarter this year. We've had annual inflation of 6.0% or more since the end of 2021.

The RBNZ targets maintaining inflation within 1% to 3%, with an explicit target of 2%. Inflation has been outside of the target range for over two years, raising concerns that 'inflation expectations' may become ingrained and with them inflationary wage and price setting. The RBNZ is trying to kill these 'inflationary expectations'.

This is the statement from the Reserve Bank:

The Monetary Policy Committee today agreed to maintain the Official Cash Rate (OCR) at 5.50%.

The current level of interest rates is constraining spending and hence inflation pressure, as anticipated and required. The Committee agreed that the OCR needs to stay at restrictive levels for the foreseeable future to ensure annual consumer price inflation returns to the 1 to 3% target range, while supporting maximum sustainable employment.

The New Zealand economy is evolving broadly as anticipated. Activity continues to slow in parts of the economy that are more sensitive to interest rates. Labour shortages are easing as overall demand softens and immigration adds to labour resources. Headline inflation and inflation expectations have declined, but measures of core inflation remain too high.

Globally, economic growth remains below trend and headline inflation has eased for most of our trading partners. Core inflation remains high in many countries. Weakening global economic growth is putting downward pressure on New Zealand export prices.

The imbalance between demand and supply is moderating in the New Zealand economy. However, a prolonged period of subdued spending growth is still required to better match the supply capacity of the economy and reduce inflation pressure.

In the near term, there is a risk that activity and inflation measures do not slow as much as expected. Over the medium-term, a greater slowdown in global economic demand, particularly in China, could weigh more on commodity prices and overall New Zealand export revenue.

The Committee is confident that with interest rates remaining at a restrictive level for some time, consumer price inflation will return to within its target range of 1 to 3% per annum, while supporting maximum sustainable employment.

Summary of Monetary Policy Committee meeting:

The Monetary Policy Committee discussed recent developments in the New Zealand economy. The Committee agreed that monetary conditions are restricting spending and reducing inflationary pressure as anticipated. While supply constraints in the economy continue to ease, inflation remains too high. Spending needs to remain subdued to better match the economy’s ability to supply goods and services, so that consumer price inflation returns to its target range.

Global economic growth remains below trend for most of our trading partners. While global growth was resilient across the first half of the year this is beginning to fade, particularly in China. Globally, headline inflation has declined but core inflation remains high in many countries. The Committee noted that regional divergences in the moderation of core inflation are beginning to emerge.

New Zealand’s export volumes over the last quarter were more resilient than expected due to favourable agricultural growing conditions in some regions. However, export revenues are expected to ease, in line with weakening global demand. A decline in global commodity prices has seen prices for New Zealand’s exports moderate.

The Committee noted that tight monetary conditions continue to constrain domestic spending. The slowdown in economic activity is most notable in the parts of the economy that are more sensitive to interest rates. The Committee judged that with monetary conditions remaining restrictive, they expect to see further declines in consumption per capita and for GDP growth to be subdued over coming quarters.

Annual CPI inflation declined to 6.0% in the June quarter, with tradables inflation declining more than non-tradables inflation. Most measures of inflation expectations have declined alongside the fall in headline inflation. However, measures of core inflation remain near their recent highs.

The Committee discussed the labour market and agreed that capacity pressures have begun to ease. Recent net immigration has increased labour supply, helping to alleviate some labour market shortages. Employment growth remains resilient. The Committee noted that most measures of annual wage inflation have begun to ease.

The Committee noted that the estimate of the nominal neutral OCR has increased by 25 basis points to 2.25% within the projections, consistent with the Reserve Bank’s indicator suite. The Committee agreed that the current level of the OCR remains contractionary and is constraining domestic spending as needed.

The Committee discussed the increase in the current account deficit and noted that this is primarily due to reduced services exports stemming from the COVID-19 pandemic as well as excess domestic demand. The current account deficit is expected to steadily narrow. Members noted that net foreign liabilities have declined over recent years and that risks associated with funding the deficit were low, as most foreign debt is hedged against foreign exchange risk.

The Committee discussed the recent strong growth in net immigration. The overall impact on demand and inflation pressure remains uncertain. Members noted that the current increase in net immigration may be less inflationary than previous increases, due to both changes to the composition of migrants and in the context of a tight domestic labour market.

The Committee noted that house prices appear to have stabilised. Members agreed that the current projection for house prices was reasonably balanced, remaining around estimates of sustainable levels. The Committee agreed that house price changes have an impact on household wealth. However, members agreed the willingness to consume out of wealth can vary and may be lower in the current context of high debt servicing costs.

The Committee discussed the balance of risks for inflation, output, and employment. Members noted that current projections are for subdued GDP growth, rather than a sharp downturn.

In discussing near-term risks, members considered upside risks to activity and inflation. Members discussed the impact of recent administered price increases – for example, council rates and excise tax – on headline inflation for the September quarter and noted that this could pose a risk to inflation expectations. Members also discussed risks around a slower easing in the labour market resulting in wage inflation taking longer to decline.

The Committee noted that the projections for government expenditure and revenue are predicated on Budget 2023 forecasts. Overall, real government consumption and investment spending as a share of potential GDP is projected to decline over the forecast horizon.

Over the medium term, the Committee discussed risks around the outlook for global growth and judged that these were skewed to the downside. A greater slowdown in global growth would likely see a fall in import prices. Members noted that weaker global demand, particularly from China, could weigh further on commodity prices and therefore on export revenues.

Members also discussed the risks around the lagged effect of previous monetary tightening on households and businesses. The average mortgage rate on outstanding loans is expected to rise from around 5% to near 6% by early 2024, and debt servicing costs as a share of income are still increasing.

Members discussed the risk to those parts of the economy most exposed to lower commodity or asset prices. The Committee agreed that the slowdown in economic activity will not be even across sectors of the economy, due to global factors and the varied impact of high domestic interest rates. In particular, the Committee noted that pockets of stress were beginning to emerge for some households, and the commercial property, agriculture, and construction sectors.

The Committee agreed that in the current circumstances, there is no material trade-off between meeting the Committee’s inflation and employment objectives and maintaining the stability of the financial system. Members noted that debt levels are high in some parts of the economy and debt servicing costs have increased. While broad indicators of stress have increased, non-performing loans remain at low levels.

In discussing their Remit objectives, the Committee noted inflation is still expected to decline within the target band by the second half of 2024. The Committee agreed that the risks around the inflation projection remain balanced. Employment is above its maximum sustainable level, however, recent indicators show that labour market pressures continue to ease.

The Monetary Policy Committee discussed the appropriate stance of monetary policy. The Committee agreed that interest rates still need to remain at a restrictive level for the foreseeable future, to ensure annual consumer price inflation returns to the 1 to 3% target range while supporting maximum sustainable employment.

On Wednesday 16 August, the Committee reached a consensus to maintain the Official Cash Rate at 5.50%.

The August Monetary Policy Statement is here.