Stubbornly high inflation expectations are highlighting the challenge that remains for the Reserve Bank (RBNZ) in stamping out inflation, ANZ economists say.
In their NZ Weekly Data Wrap the ANZ economists reiterate that despite downside risks to economic growth continuing to build, they still see "upside risks" to their forecast for a peak Official Cash Rate of 5%. Currently it is on 3.5% with universal expectations of another sizeable hike (the ANZ economists expect 75 basis points) at the next review on November 23.
The economists said the upside risks were were reinforced last week by the RBNZ’s latest quarterly Survey of Expectations.
"It was all bad news, with inflation expectations rising across the curve, despite survey respondents also anticipating a much higher peak in the OCR. Essentially, inflation was seen as being much stronger and more persistent, even in the face of the rapid rate rises the RBNZ has delivered."
They noted that the sample size of the survey is a mere 33 “business leaders and professional forecasters”, so it’s not capturing the expectations of Kiwi businesses and households at large.
"But it does highlight that forecaster expectations are moving further towards the ‘RBNZ losing credibilty’ end of the spectrum, which would support super-sized 75bp OCR hikes in the next two meetings as the RBNZ defends its inflation target."
The economists say the latest Survey of Expectations "joins an array" of broader measures of inflation expectations that have remained "worryingly high" in recent months and that are "certainly not consistent with strong inflation dissipating any time soon".
"For example, in the October ANZ-Roy Morgan Consumer Confidence survey inflation expectations were little changed at 5.0% (5.1% previously). That’s down from peaks seen earlier in 2021, but remains well above pre-pandemic ranges of 3-4%. In our ANZ Business Outlook survey, inflation expectations bounced to 6.1% in October (6.0% previously), remaining close to their recent highs. Cost expectations and pricing intentions have eased modestly from extreme highs, but again are still far too strong to be consistent with low and stable inflation being achieved in the near term.
"Stubbornly high inflation expectations across a number of different surveys highlight the challenge that remains for the RBNZ. Yes, they have delivered significant monetary tightening in a very short period of time, and yes, that’s going to slow down the economy over 2023. But with expectations of high inflation becoming embedded into wage and price setting behaviour, it’ll take a concerted effort to tamp down wage-price spiral dynamics that are becoming ever more established in the New Zealand economy.
"As we note in our latest Quarterly Economic Outlook, recession risks are rising, but when price stability is at stake, getting inflation back down is priority number one."
Westpac senior economist Satish Ranchhod, in Westpac's latest Weekly Economic Commentary said the elevated level of inflation expectations "is a big worry for the RBNZ".
"Expectations, especially over longer horizons, are a key influence on how businesses adjust prices and wages. Their recent rise signals that the current inflation cycle could be even more protracted."
The Westpac economists are also predicting a 75 basis-point rise in the OCR on November 23 and with further rises to come next year.
"One of the major complications in the RBNZ’s fight against inflation is the prevalence of mortgage rate fixing. Around 90% of New Zealand mortgages are on fixed rates, and many of those are still locked in at the very low interest rates that were on offer in the early stages of the pandemic. That’s meant large numbers of households are yet to feel the impact of rate hikes to date, which has allowed them to maintain their spending patterns," Ranchhod said.
"That picture will change dramatically over the coming months, with more than half of all mortgages coming up for repricing over the next 12 months. In many cases borrowers will face refixing at rates that are 3 percentage points higher than those they are currently on. And as that occurs, we’re certain to see a slowing in domestic demand.
"But while we wait for the full impact of interest rate hikes to date to ripple through the economy, we’re still left with a picture of sizzling inflation pressures. And that leaves the RBNZ with a tough balancing act. Taking a more gradual approach and waiting to see the full impact of rate hikes could actually mean more pain in the longer term if inflation pressures do not ease off. In contrast, more aggressive rate hikes now could risk a sharper than necessary downturn in economic activity and employment.
"Ultimately, we expect the RBNZ will maintain its ‘stitch in time’ approach. That means the central bank is likely to continue to front load its policy tightening. And on balance we think that is the right approach, especially given the clear upside risks for inflation expectations. Indeed, if the RBNZ doesn’t get in front of those pressures soon, the New Zealand economy could realistically find itself mired in a wage-price spiral. That would impose serious harm on households and the economy more generally, with ongoing pressure on living costs and weakness in economic activity," Ranchhod said.
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