Lower interest rates may be on the horizon after the Reserve Bank said it was paying attention to repeated warnings the economy could be faltering faster than it had planned.
Just two months ago, RBNZ’s Monetary Policy Committee suggested the Official Cash Rate should be held at 5.50% until August next year and could even go up another 25 basis points.
This hawkish view seems to have evaporated, with the committee instead discussing the risk that policy settings were weighing on demand too heavily during its July meeting.
The record of meeting said there was now proof the economy was operating below its potential capacity, and recent surveys and data showed business activity was declining.
“Members discussed the risk that this may indicate that tight monetary policy is feeding through to domestic demand more strongly than expected,” it said.
Jason Wong, a senior market strategist at BNZ, said these comments had thrown open the door for rate cuts.
“Gone was the May language of discussion of a rate hike and the MPC looks like it has taken on board the recent flow of woeful economic activity data,” he said.
In recent weeks, high frequency data have been flashing warning lights last seen during the Global Financial Crisis in 2007-08 and the short-lived pandemic crash in 2020.
This prompted some economists to rethink their OCR forecasts and may have caused the RBNZ to do the same.
Abhijit Surya, an analyst at Capital Economics, said the central bank had suddenly dropped its usual line that interest rates needed to remain restrictive for “a sustained period”.
Instead, the RBNZ’s new line is: “the extent of this restraint will be tempered over time consistent with the expected decline in inflation pressures”.
This overly poetic turn-of-phrase simply means that rates will be cut as inflation decreases.
Spring clean
While still unlikely, this raises the possibility that interest rates could be cut at the August and October meetings. Markets are now priced for the OCR to be below 5% in November.
That price could indicate regular size cuts starting in August, or RBNZ using a 50 basis point cut in October or November to kick off the easing cycle with a bang.
Wong said it was more likely that cuts would begin in November, as the RBNZ preferred to make big changes alongside a full Monetary Policy Statement and August might be too soon.
UBS economist Nic Guesnon said he hadn’t expected the Reserve Bank to change its tone so soon and there was now a “material” chance of a rate cut in August.
But Surya agreed the Reserve Bank would want to wait until hard data had confirmed what economists were currently reading in the tea leaves.
“However, with the Q3 CPI data likely to show inflation back in the target range, it seems like a policy pivot in November would be a no-brainer for the Bank,” he said.
And once monetary policy begins to be loosened, it could unwind fast. Capital Economics expects the OCR to settle at 3.5% by the end of 2025.
Flimsy flip-flop
Among the chorus of voices heralding imminent rate cuts, some economists were still sounding a note of caution.
Sharon Zollner, the chief economist at ANZ, said the market reaction was understandable as the record of meeting “read like a mini-pivot”.
“Although we think it’s a stretch to call this a full blown pivot given the Committee’s assessment of balanced risks around inflation and their caution around the impact of tax cuts,” she said.
It was becoming more likely that the easing cycle would begin in November but Zollner was sticking with her February forecast for now.
Infometrics chief forecaster, Gareth Kiernan also said he would hold on to his forecast for February until the central bank gave some more solid guidance.
It was only six weeks ago the committee was talking about hiking interest rates, he said.
“The Reserve Bank’s habit of flip-flopping and changing the tone of its message from one statement to the next means we remain cautious about the timing of the first cut to the OCR.”
“It’s hard not to get frustrated trying to divine how the Committee can pivot its view so substantially every six weeks”.
All the recent monetary policy decisions have been unanimous and the specific words used in the record of meeting are also signed off by all members of the committee.
Consumer Price Index data next week and labour market statistics in early August will help confirm or contradict the recent high frequency data.
Kiernan said economic data may need to be materially weaker than the central bank has already forecast to justify starting its easing cycle 10 months earlier than planned.
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