ANZ economists are still forecasting another Official Cash Rate hike next year and say domestic inflation is still sky high, and yet to capitulate, while 'a lot still needs to go right' for the OCR to not need to eventually go higher

Economists at the country's biggest bank are still forecasting another Official Cash Rate (OCR) hike early next year and see risks tilted towards inflation holding up longer than acceptable.

In ANZ's latest Quarterly Economic Outlook, the economists reiterate that they have "pencilled in" a 25 point hike by the Reserve Bank (RBNZ) to the Official Cash Rate (currently on 5.5%) for February 2024.

"Inflation targeting isn’t likely to be ‘easy’ any time soon. We’re yet to be convinced that the moderation in domestic inflation is occurring fast enough to secure progress. We think the balance of risks continues to be that that will ultimately require a higher OCR," the economists say.

"...But with some of the recent [economic] data suggesting the imbalance between aggregate supply and demand may be resolving a little faster than expected, risks are shifting towards a later resumption of hikes, or if the data flow keep surprising on the less-inflationary side, perhaps no further hikes this cycle at all.

"But let’s not get ahead of ourselves: domestic inflation is still sky high, and yet to capitulate. A lot still needs to go right for the OCR to not need to eventually go higher."

And in the introductory comments in the publication, ANZ chief economist Sharon Zollner says although demand is cooling, "it’s still a long road" to the 2% 'midpoint' target of the Reserve Bank's 1% to 3% desired inflation range.

"...A lot of ducks have to line up: oil prices, inflation expectations, the housing market, and the labour market all have to play ball.

"...Overall we still see risks tilted towards inflation holding up longer than is acceptable, with the RBNZ hiking again in 2024."

As of the September quarter inflation measured by the Consumers Price Index (CPI) came in at 5.6% down from 6.0% as of June. But the domestically-sourced 'non-tradable' inflation was at 6.3%, albeit down from 6.6%. The domestic inflation has proven 'sticky'.

"The economy is slowing, but domestic inflation is still very high, and the RBNZ’s forecast that it’s about to suddenly drop away still feels optimistic," Zollner said.

However, she said it is clear that at the moment there is "no smoking gun" to prompt a deviation by the RBNZ from its current 'watch, worry, and wait' stance.

The RBNZ has its last OCR review for the year on November 29 and it is now just about universally expected that there will be no rate hike. The next review is not till February 28, 2024.

Zollner points out that by the time of the February review the outcomes of the next major batch of quarter economic data - CPI, GDP, unemployment and wage figures - will be known, including "a bunch more monthly indicators as well".

"We love all data, but we’ll be particularly watching for:

• More evidence on the demand impact of migration, particularly on the housing market (rents and house prices).

• Whether our commodity prices are going to continue to lift, or slump once more.

• Whether the improvement in business sentiment seen over the year continues, or whether the lagged impacts of monetary policy mean the shoe is about to drop."

Zollner said that "of course" there has been an election as well, but felt that any change to fiscal settings is unlikely to result in a material change in broad economic conditions any time soon - "fiscal policy is a slow ship to turn".

"Even if we do see a mini Budget this year, in terms of macroeconomic impacts it’s likely to be more ‘mini’ than ‘budget’.

"However, looser housing-related policy is likely to act as a slightly stronger economic tailwind than otherwise."

Zollner said the ANZ economists see the economy "muddling through, with some unders and overs, and certainly winners and losers as the big forces (monetary, fiscal, global and demographic) that are buffeting the economy play out".

"But unfortunately, whether more medicine via another OCR hike is needed to bring it about or not, it’ll likely feel like hard yards overall.

"Strong population growth will mask the weakness that’ll be more evident in per capita spending as people watch their pennies.

"We see the unemployment rate continuing to rise.

"The agricultural sector is contending with a significant reduction in incomes with export prices low and operating costs (including interest costs) trending higher.

"But hopefully, the reward for all this restraint will be steadily falling inflation and an improving balance both fiscally and with the rest of the world that will set the economy up for future success."

In the main body of the publication and regarding migration, the economists say that their prior expectation for a net inflow of 75,000 people over 2023 was too low.

"We now see this coming in closer to 120k, and that’s assuming a moderation in the pace of monthly inflows over the remainder of the year."

On housing, the economists say while the impacts of net migration on CPI inflation are ambiguous (as it adds to both supply and demand), the impacts on activity and the housing market are not.

"Strong population growth is underpinning both rents and housing market activity."

They said that all in all, despite looser Government housing policy and surging migration, they think higher mortgage rates and a softening labour market will continue to cap borrowing capacity and demand more broadly, limiting the upside for house prices.

"But the RBNZ will be nervous about a possible resurgence in the housing market over the coming summer, as that would suggest monetary tightening may not quite be getting the sustained traction that’s needed to get CPI inflation lower in a reasonable timeframe. Our house price forecast is for relatively modest growth from here, but we are braced for a stint of potential data surprises in the near term as election-related noise infiltrates the upcoming data."

On the labour market, the economists are expecting to see it "cool fairly quickly from here". Unemployment rose to 3.9% in the September quarter from 3.6% as of June.

"Weaker labour demand as economic activity softens, combined with solid growth in labour supply from net migration are together expected to see the unemployment rate rise to a peak of 5.3% in 2025."

On inflation, the ANZ economists expect 'headline inflation' to return to the RBNZ’s 1% to 3% target band by the end of 2024, helped by the "tailwind" of falling tradables (imported) inflation.

"But once the normalisation in tradables inflation has occurred, we see tradables inflation rising again, which could leave inflation stranded above the 2% target midpoint. Obviously anything that far out is massively uncertain, but there are plenty of arguments why global inflation could settle higher than experienced last decade: climate change, geopolitical fragmentation, increasing trade protectionism and re-shoring.

"Relying on tradables inflation to solve our inflation problem leaves us vulnerable. It could only take another negative supply shock to see the tradables tailwind switch to a headwind."