David Hargreaves says in contrast to the position it was in a year ago, the Reserve Bank will need to make a 'do nothing' Official Cash Rate decision in the coming week in a sufficiently 'hawkish' way that keeps pressure on inflation over summer

Well, here we are again. In the blink of an eye we are approaching that very important last Official Cash Rate (OCR) review for the year.

It seems like only five minutes ago I was previewing the last OCR review of 2022. But much has changed.

As I said then, all the talk in the run-up to the November 2022 OCR review was not if we would get an OCR hike, but whether it would be "large - or extra-large". In the event Reserve Bank (RBNZ) Governor Adrian Orr and his merry band of Monetary Policy Committee members came out swinging, with a record "jumbo hike" of 75 basis points to send us all off staggering into the festive season. 

Given that there is now customarily a three-month break (a long time in economics) between the last OCR review of the year and the first of the next, the logic of that super hike was sound. With inflation by no means under control the RBNZ basically covered itself for the summer break.

So, what about this year? The problem's the same. Inflation. But the situation's quite different. There is NO CHANCE of an OCR hike when the MPC meets to review the situation this coming Wednesday (November 29).

The backdrop is that key economic indicators are beginning to behave in the way the RBNZ wants. And it's fair to say also, behaving in the way the RBNZ has picked. Its forecasting performance in certainly the last six months has been very good - picking what's been a rapid cooling in the economy in the second half of the year.

The central bank's job is to keep inflation (as measured by the CPI, the Consumers Price Index) in a 1% to 3% range, with an explicit target of 2%. The RBNZ began this OCR hiking cycle in October 2021 as inflation began to soar. Inflation peaked at 7.3% in June 2022. Job most certainly NOT done.

After that jumbo rate hike in November 2022 the OCR stood at 4.25%. This year we saw hikes in February (50 points), April (another 50) and then May (25 points), taking the OCR to the current 5.5%. At that point the RBNZ declared (through its set of forecasts) that it was done with hikes - at least for the foreseeable future.

This has worked well. By putting away the spectre of future hikes the RBNZ was able to keep a relatively low profile during the election campaign - a campaign which could easily have seen our central bank become a political football if it had been undertaking rate rises during the campaign.

All might not have been so good of course if the economic data had gone the wrong way. But it is moving increasingly in the right direction. The RBNZ's last set of forecasts in its August Monetary Policy Statement were for the annual rate of inflation to be 6.0% as of the September quarter. The actual rate undershot this at 5.6%. The RBNZ had forecast unemployment to lift from 3.6% to 3.8% in the September quarter. It actually rose to 3.9%.

So, right at this moment, the inflation fight is on track. That, strangely, poses its own challenges for the RBNZ.

What is Governor Orr to do in the coming week? Announce no change to the OCR, say that there will no more future hikes, and that everything is just wonderful, it's all on track, and have a great summer break? Well, no. That would not be a great idea.

For one thing, if we look closely at the inflation figures we can see that domestically-generated inflation's still way too high and dropping only very slowly. In fact, the so-called non-tradable inflation figure for the September quarter was an annual rate of 6.3%, which is exactly the SAME as it was in June 2022 when the 'headline' rate hit that 7.3% peak. So, no room for relaxing there.

Then there's 'the markets'. The wholesale interest rate markets love to second guess. Back in 2021 our mortgage interest rates started increasing before the OCR had been moved. That's because the wholesale interest rate markets had begun anticipating hikes - so wholesale rates were pushing up strongly. And that of course affected the funding costs of the banks - so up went the mortgage rates.

Therefore, although inflation is starting to recede, there's a couple of things the RBNZ does NOT want to happen this summer. And they are linked. The two things would be signs of falling mortgage rates and signs of the housing market waking up.

The RBNZ has a new Monetary Policy Statement also coming out on Wednesday at the same time as the OCR decision.

The forecasts contained in the back of that new MPS will be of vital interest.

Will the RBNZ change its view of how long the OCR going to stay high? Will it indicate that there's no further chance of any more hikes?

In the August MPS forecasts the RBNZ didn't forecast any rate reductions till the second quarter of 2025. That's a long way away. What will the central bank say this time? The inclination might be to modify that rate track and bring forward the time of the first OCR cut. HOWEVER. Our friends in the wholesale markets would for sure seize on that and start to pre-empt, with wholesale rates starting to fall quickly.

Already (at time of writing) the wholesale markets are 'pricing in' three full 25 basis point cuts to the OCR by February 2025 - IE by BEFORE the RBNZ is currently forecasting there will be even ONE cut. It's called jumping the gun. Or is it adroit anticipation? Either way, it's potential a pain in the painful spots for the RBNZ if 'lower, sooner' starts to be the perception. Because as mentioned above, this would likely lead to lower mortgage rates. So monetary policy would effectively be 'eased' before the RBNZ is ready - potentially.

This was always going to be the difficult juggling act for the RBNZ once we got over the inflation hump and started moving down the other side. From the RBNZ perspective, if it lets the brake off too fast then there is a real risk that much higher than desirable (IE above 3%) inflation becomes ingrained and with all the economic poison such a reality would entail. 

Putting this all together would indicate that the RBNZ will be of a mind to leave well alone. It would be a surprise if the forecast OCR track is changed much, if at all. Maybe the RBNZ would bring forward the first cut by a quarter or something like that. Or maybe just leave it as was in August. What about the slight chance of a future hike that the RBNZ had in its previous set of forecasts? I suspect this will be retained too.

Likewise, the commentary in both the MPS and the Governor's remarks to the media could be expected to retain much of the previous 'hawkishness'. 

I would hope and expect there's some more detailed reference to the migration flood NZ is currently experiencing. And the potential ramifications. The RBNZ devoted a lot of space to the subject in its August MPS, but has to date been playing down the inflation risks from the current migration surge. 

Since August, however, the numbers of migrants have just kept going up and up, with the annual net migration gain running at now well over 100,000 people.

Undoubtedly this is a big factor in the labour market rapidly losing heat. So, that's actually a positive for the RBNZ. But...

The flip side though is just what the demand-side implications - and therefore the inflation implications - are for the economy from this migration surge. More people mean more need for housing, and for infrastructure and for services. It's inflationary. And the RBNZ has an inflation problem. So, this seemingly unchecked pouring in of migrants is potentially petrol for inflation's fire.

Right now, the RBNZ seems to have the fight against inflation heading in the right direction. But it would be very easy to stumble off the path.

For the RBNZ, the 'on hold' decision it will deliver for the OCR in the coming week is the easy part.

The hard bit is getting across the message that the inflation battle is not won and now is not the time for falling interest rates and getting too relaxed. And the RBNZ has to make this message stick for the whole of the three-month summer break.  

*This article was first published in our email for paying subscribers early on Friday morning. See here for more details and how to subscribe.