Economists are cheered by signs the Reserve Bank's monetary tightening is getting traction but caution that inflationary pressures are still strong

Economists are cheered by signs the Reserve Bank's monetary tightening is getting traction but remain concerned about the strength of inflationary pressures in the economy.

The much-watched NZIER Quarterly Survey of Business Opinion (QSBO) for the September quarter was released on Tuesday and showed business confidence was improving slowly, the labour market was starting to show signs of slack [as the RBNZ wants to see], but cost pressures - while easing - remain strong. The RBNZ will not want to see that as it strives to get inflation back into its targeted 1% to 3% range. The next inflation figures are out on October 17, but as of the June quarter annual inflation was 6%.

The RBNZ pays close attention to this survey, not least because it is very long-running, dating back to 1961. And these latest results have come out just a day before the RBNZ was due to have its latest review of the Official Cash Rate. The OCR is currently on 5.5% having been hiked to that level all the way up from 0.25% as of October 2021. 

ANZ senior economist Miles Workman and economist Andre Castaing say the latest QSBO data suggest the RBNZ’s monetary tightening to date is getting traction and that migration-induced labour supply is having a big impact. 

However...

"While capacity and inflation indicators improved, there are still questions around whether the economy is slowing sufficiently to get inflation down in a reasonable time frame," the economists said.

"If we are indeed past the worst of the slowdown, as some of today’s data might suggest, then the RBNZ may not be getting the traction it thought it was getting back in August [at its last OCR review].

"A premature reacceleration in activity and therefore inflation pressures will be a big worry for the RBNZ. But for now, the overall read from the QSBO is that things are moving in the right direction. Even though, the RBNZ will be very aware of the dangers of assuming a straight-line interpolation from here. As we’ve said previously, getting headline inflation to slow from over 7% y/y to around 5% should prove relatively easy. Getting it to the 2% target midpoint [of the 1% to 3% inflation target range] (and driving sticky domestic inflation lower) is likely to be more of a challenge."

In ASB's earlier preview of this week's OCR review its economists changed their earlier call that the RBNZ would start cutting the OCR next year - and pushed the timeframe out as far as 2025. Senior economist Mark Smith said in that preview: "We believe that the RBNZ will remain wary of further upside risks surfacing and err towards keeping monetary conditions tight for longer as insurance to ensure the eventual return of sub-3% inflation. As such, we now anticipate OCR cuts will kick in a little later than we had previously expected, with early 2025 looking more likely than August 2024."

In his review of the QSBO results, Smith said the survey showed modest improvement, with readings for domestic trading activity pointing to a flat period of growth.

"However, the economy looks set to struggle for traction heading into 2024. Likely reflecting election-related uncertainty and high interest rates, investment intentions have not improved appreciably. Strong net immigration looks to be helping to continue significantly easing frictions in the labour market and should help to cool pressures in medium-term inflation," he said.

"Pricing and cost metrics, whilst lower, remain too high to be consistent with sub 3% inflation.

"The RBNZ is expected to remain wary and is unlikely to cut the OCR until it is supremely confident inflation will settle in the 1-3% target range. This looks to be a 2025 story to us," Smith said.

Smith is not expecting the RBNZ to need to move the OCR higher still.

"However, inflation is still much too high. We expect the RBNZ will tread cautiously and will err in favour of keeping conditions for tight for too long rather than easing policy prematurely. OCR cuts are unlikely until as far away as early 2025."

BNZ head of research Stephen Toplis said The clear message in the latest QSBO is that the labour market continues to soften "and aggressively so".

"We have long said the secret to stabilising prices in the medium term is to alleviate the excess demand that had developed in the labour market during the Covid era. We maintain that view," he said.

"...All told, we think today’s data significantly increase the likelihood the RBNZ will look through near term upside surprises in the CPI. Near term inflationary concerns are very real and there remains the risk that an incoming government eases fiscal policy in an inflationary manner.

"However, we think the Reserve Bank needs to trust the lags. The economy has stalled, the labour market is easing rapidly. It would be very unusual times indeed if this didn’t dent inflation in due course. The RBNZ may need to keep interest rates elevated for longer to achieve its objectives but there is little evidence crushing the economy any further is warranted," Toplis said.

Westpac senior economist Satish Ranchhod said with a continued softening in economic activity, there’s been a notable easing in labour market tightness. 

"The news on inflation is more mixed. The number of businesses who raised their prices over the past three months has dropped back, as has the number of businesses who are planning to raise their prices. However, both of these measures are still at historically elevated levels, consistent with inflation lingering well above 3%. It was an even more worrying picture on the cost front, with large numbers of businesses reporting that operating costs have continued to rise over the past few months.

"Putting this altogether, we’re left with a picture of subdued economic conditions through the latter part of the year. That matches our expectations for weak economic growth in the September quarter. But even though economic activity is cooling, inflation pressures are easing only gradually. That reinforces our expectations that the RBNZ will retain a tightening bias at its policy review tomorrow," Ranchhod said.

Kiwibank senior economist Mary Jo Vergara and economist Sabrina Delgado said the lift in business confidence is encouraging, "but it’s not all good news".

"Other indicators in NZIER’s survey support our expectation for weak growth in the coming quarters. The unprecedented rise in interest rates is weighing on household consumption and business investment. That’s not an environment conducive for growth. But a slowdown in activity is needed to rebalance our economy and return inflation to target.

"We don’t think today’s report will see the RBNZ change its tune tomorrow. They’ll cheer the evidence of an easing in labour market capacity pressures, but flag the inflationary risks of stubbornly high cost pressures. Clear softening in demand, however, suggest that financial conditions are already tight, and no further tightening is needed. We expect the RBNZ will hold steady tomorrow," Vergara and Delgado said.