Well, it's taken three and a half years of eye-watering interest rate hikes, but we got there.
The capture and placement of the inflation beast well and truly back into its 1% to 3% cage (at 2.2%) is certainly something to be happy about.
But what now?
It's not like returning the inflation rate back to its targeted levels is in itself a panacea. It won't make people spend again. It won't stop people who are struggling financially from struggling financially. It won't kickstart the economy overnight. It won't stop the current wave of job losses. Etc, etc, etc.
No. We NEED low inflation, but the reality is we've paid a substantial price to get it. And the woes from that won't just fix themselves.
So, what is supposed to happen next?
Well, for a start, get those pesky interest rates right down. NOW! Do you hear me?!
And, no, those are not actually my sentiments. I'm just giving a representation of what seems to be an increasingly strident wall of sound around inflation and interest rates.
Walking a dangerous path?
It already seems to me that some folk appear prepared to believe that whacking interest rates back down as fast as possible will fix if not everything, then certainly a lot of things, and quickly.
Well, interesting. But isn't there a bit of danger down that path as well?
Some context is needed.
When the inflation rate first veered dangerously out of the 1% to 3% zone in mid 2021 the Reserve Bank started to act by calling on its weapon of choice the Official Cash Rate, which at that point was at the historically low 0.25%. Between October 2021 and May 2023 the RBNZ drove the OCR up, at record speed, to 5.5%.
Inflation was stubborn. Domestic inflation fired up. We naughty people started getting pay rises. Prices went up. The RBNZ was forced to go higher and faster with the OCR moves than it expected. Ultimately Governor Adrian Orr conceded the central bank was deliberately trying to engineer a recession. That took a little while to arrive, but mission eventually accomplished.
Fast forward to August 2024 and the downward leg of the journey began, with a 25 basis point cut from the RBNZ to 5.25%. This was in short order followed by the 50 bps cut this month.
It's well worth mentioning that in the RBNZ's August Monetary Policy Statement (MPS) our central bank was forecasting the OCR would be cut to 4.75% by the end of this year.
Guess what? We're already there and there's one more OCR review for this year to go yet! And the expectation (or is that a demand?!) is for another - at least 50 bps - cut before the lights go out on 2024. Yes, you read that right - 'at least' 50. There are those suggesting the next cut should even be 75.
How fast?
For example, Abhijit Surya, Australia & New Zealand economist with independent economic researchers Capital Economics said with the NZ economy as weak as it is, "we can’t rule out the possibility that the RBNZ opts for a larger 75bp cut in November, as opposed to the 50bp cut that both we and markets are expecting".
Greg Smith, head of retail for investment management firm Devon Funds was suggesting (and this was ahead of last week's 'mere' 50 bps cut) that the RBNZ should get the OCR down to 3.75% by Christmas.
The rationale is that the OCR is currently still at very restrictive levels, so, now that inflation is back in the box, the OCR should be as quickly as possible restored to a 'neutral' setting.
In the world of central banks a neutral interest rate setting is a Goldilocks measure - not too hot nor too cold, it's neither restrictive nor stimulatory.
How the 'neutral' interest rate is arrived at is as clear as mud and there are various ways of measuring it and over various timeframes. But we'll have a go.
The RBNZ's most recent depiction of a 'short term' (one-to-two years) 'neutral' rate for the OCR is 3.8%. So by that criteria the current 4.75% OCR is still restrictive and if we follow the logic that neutral should be arrived at as soon as possible then a 3.75% OCR by Christmas does make sense.
The financial markets as ever are gagging for it. Current wholesale interest rate pricing has 55 bps worth of cuts priced in for the next OCR decision on November 27. That's a bit confusing, but it means the markets are convinced the next cut will be at least a 50-pointer and there's about a 20% chance it'll be a 75-point jumbo cut. [Update, as of later on Wednesday the market was now pricing in a 40% chance of a 75 pointer - so, nearly 50-50!]
Everybody seems to think we need to be in a tearing hurry to get interest rates back from non-restrictive levels. But do we really?
Yes, some businesses and people are doing it really tough out there.
But some are not.
The worry would be if we really slash interest rates now, people who've been sitting on the sidelines with pockets full of cash will make hay. The obvious area to worry about would be the residential property market. It's slow now, but we've seen before the way falls in interest rates can act like petrol on a fire with the housing market.
And look at the banks at the moment. They are accustomed to being able to gorge on residential mortgage business and the way they are really jostling for position with mortgage cuts currently tells you they want the housing 'machine' to be 'switched on' again. They NEED it.
Unfortunately the impacts of high interest rates have not fallen uniformly. Remember, the RBNZ reckons only something like a third of us have mortgages.
Have patience
The risk as I see it with dropping interest rates too far too fast is that we get a very uneven recovery. We could be faced with the sight of businesses and individuals still struggling, even as cashed-up people try to start another housing boom. And what might that do to inflation?
Domestically-sourced, or 'non-tradables' inflation came in at an annual rate of 4.9% in the September quarter - which was down from 5.4% previously and was lower than the RBNZ's pick of 5.1%. This was encouraging news and does perhaps back up sentiment that the domestic inflation IS now going to start to really fall.
But 4.9% is still too high and offers no room for complacency, particularly not when you see big contributions within that coming from rents and local authority rates and payments.
Having spent the last three-and-a-half years battling to get inflation under control, and by sinking into a long-running, grinding recession to do so, we should not lose patience now and assume we can just 'fix everything' by dropping interest rates like a brick.
More patience will be needed, I feel. Surely safety first is the best option. We got inflation down. We need to keep it down.
Oh, yes, plenty of people are already saying inflation's kicked and it's over. Don't worry about it. But are at least some of these the same people who said not very many years ago that inflation would never be a 'thing' again and nor would high interest rates?
We need to see inflation stay in the target band and we need to carefully get the economy back on its feet again - and don't try to rush it. It may take time. And we can't just assume that rapidly lowering interest rates will actually speed up the recovery. As mentioned above, there's a few ways we could hit 'speed bumps'.
And if all this seems unreasonable, let's just ask ourselves how we would feel if having gone through all this, we then find sometime next year that inflation's not in fact dead and we need to look at higher interest rates again.
No. Let's do this once. And let's do it right.
53 Comments
All very sensible.
Chances of that happening? Slim
Because like Pavlov's Dogs we only have one thing on our mind. Not the next meal and what it's price might be, but Property Prices and how we can get those prices going back up a soon as possible.
We have the answer to that. The RBNZ has more tools to apply now, but does it have the courage needed, that you say we need? I hope so.
Because like Pavlov's Dogs we only have one thing on our mind. Not the next meal and what it's price might be, but Property Prices and how we can get those prices going back up a soon as possible.
That's somewhat close to my reckon and the general consensus around the water cooler ecosystem.
Consumer price inflation is tamed and things go back to 'normal'. The Ponzi moves back to center stage (not that I ever thought it went away) and chugs along dancing to the beat of the 7-10 year theory. At least, that's what people are hoping.
An article using revisionist history to overlook the RBNZ's past ineptitude, to justify the RBNZ's current ineptitude? I certainly think so.
And I note:
- No mention of the RBNZ using LVRs and DTIs to address house price inflation
- No qualifications to the vagaries built into the tradeable / non-tradeable split
- No mention of whether reducing the OCR as inflation falls (as other central banks have done!) causes us less damage while avoiding the situation we find ourselves in today
Just an aside, financial markets are not 'gagging' for anything. That's a complete mischaracterization. And an unworthy one from someone commenting on a serious subject, albeit in a lighthearted way.
Yes. And 2 years ago, the RBA told everyone that their Cash Rate would stay at 0.1% for at least another 2 years.
Do you know why both Zollner and Lowe made their respective calls? Because that's what the future looked like to both of them at the time, and neither expectation was fulfilled. And whatever it is that you, I or Blind Freddy expect to happen today will likely be just as erroneous.
And the point of all of that? Protection. Protection against the unexpected is likely the best option at this stage, given all the moving parts that we have today. If rates rocket past Sharon's call when Donald gets in; The Mullahs attack or Taiwan Falls or if the OCR does go negative, as Adrian suggested not that long ago, how will our respective situations look?
If Trump & the Rethugs take control of the purse strings you may well be right.
But if Kamala & Dems control of the purse strings, I hope they do what governments should do when they've been using fiscal deficits to soften the effects of high interest rates, i.e. tax collection gently increases, government debt gets whittled down, and the exuberance gets dampened down.
Or they could just keep kicking the can down the road.
Something in your post was bugging me. So I looked further ...
Nope. Just the 0.5% cut - as you've suggested - won't trigger inflation on its own. The Fed rate is still contractionary.
Nor will another 0.25% cut, nor another 0.25%. And probably not another. Nor another ...
But if the US government doesn't control its spending, or worse, it ramps up, then maybe.
Like I suggested ... The election outcome will be a significant factor.
David, could you clarify where this statement came from:
"The RBNZ's most recent depiction of a 'short term' (one-to-two years) 'neutral' rate for the OCR is 3.8%. "
Greg Smith, Head of Retail at Devon Funds, used it in his article. When I read it a week or so ago, I thought I'd missed something.
So I went looking for where the RBNZ thinks the neutral rate may be. Nope. No change. It's either 2.5% or 2.75% depending on which recent release one looks at, and where in the release it is used, and for what purpose. And it certainly wasn't in the extremely brief announcement last week when the RBNZ cut the OCR by 50bps.
Thus, I concluded that Greg had taken it from some forward looking OCR rate track that the RBNZ's publishes. But which one? Or am I incorrect and Greg derived it from somewhere else? Or was this your work?
Could you clarify please as you seem suggesting that Greg's rate, or your rate, is somehow a reflection of the RBNZ's neutral rate that is in fact considerably lower than 3.8%. Further, an economy's neutral rate hovers around a mid-point for years. For it to have suddenly jumped to anything near 3.8% seems unlikely and is counter to what the RBNZ understands to be a 'neutral rate' as described in the RBNZ's link you provide above.
Thanks.
Antipodean Macro had some good graphs showing the short run and long run estimates of a neutral OCR. Perhaps the source of those might have the answers?
https://www.macrobusiness.com.au/2024/10/deep-rate-cuts-incoming-as-rec…
"Currently, with elevated inflation expectations, the “neutral” OCR is around 3.9%. This compares with the actual OCR of 5.5%, which is therefore clearly contractionary"
-source https://www.rbnz.govt.nz/hub/news/2024/04/finding-neutral
Yeah. I got that via email, see the same here.
When I read it - I literally shouted "WTF" - while stamping around the room - as they jumped through hoops trying to justify a "short" and "medium" term version of a neutral OCR. There is really only is one. And that's the long term one. It's a hypothetical target, not some guiding beacon!
So how do they justify a short and medium reckons? Read these words carefully ...
"The short-term nominal NIR consists of the real NIR, plus inflation expectations over the 1–2- year horizon."
And where do "inflation expectations" come from? Well, it's basically a voodoo economics "reckons". Ask 30 or so "influencers" what they think and off we go. (Or pretend to use some model that does the same? Okay. Which one?) Is it backed up by science? None whatsoever.
Further, when your chosen 30 or so influencers provide their "inflation expectations" - they're actually INCLUDING the effects of high interest rates that the RBNZ is forcing upon us! WTF! Double counting much? I have many other issues with this nonsense so I won't go on,
What this nonsense really is - is an attempt to avoid having to admit just how badly they got it wrong. No F.U. ever looks so bad when you can simply make up arbitrary measures to pretend you're doing it right.
Hi. It's an RBNZ bulletin that is linked to in the article. But here it is again. Stress that the 3.8% is 'short term'. Hope this helps. Regards.
...and also figure 7.4 in this spreadsheet.
Thank you, David. Your reply is much appreciated.
Might I enquire as to why you chose to use the short-term measure in your article?
Surely, as you say, "logic would suggest one number would be a lot easier to follow". I completely agree. 100%. To suggest there are multiple versions of a hypothetical target number is getting a tad absurd.
But you chose to use the short term one. Could not the medium-term rate be more representative of some middle ground? Or perhaps the long-term one would be more representative of what the RBNZ itself regards as a 'neutral rate'?
No answer expected, David. I enjoyed your article. It explains much.
Depends on productivity:
“Productivity isn't everything, but, in the long run, it is almost everything. A country's ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.”
If we implement policies that are pro-productivity, like lowering electricity costs and improving the efficiency of government services, our economy will be OK. If we do not we will suffer the consequences of our own action or inaction.
What I would say is that the era of favourable demographic tailwinds is passing. If you want low inflation rates you'll need higher interest rates.
Depends whose standard of living the productivity is improving.
Many studies suggest the big productivity gains of the 80's and 90's were not shared with the workers, and the extremes between the lowest paid and highest paid since the 70's, have all contributed to the imbalances and iniquities we see today. Other studies have shown that after 6 hours your productivity is diminishing.
What happened to the 40hr week, 8hr day that Labour Day is supposed to celebrate? We're working longer hours to somehow afford our massive increases in standard of living, and going backwards.
The problem is creating the balance between economic and personal productivity. What we really have is the owners simply demanding more from the slaves with empty promises.
We are starting from a position of high private debt vs Govt debt. The extension of this ratio is going to be concerning to RBNZ and international markets. If the Ponzi fires, the fire will be short lived, as its already at its limits.
Right now there are way way way more sellers and listings then sales.
Non tradeables will fall and that could give the RB room to make a 75 point cut in November, but I don't think that would be the right thing to do, and as someone else said, the optics are bad. A big element of non-tradeables is rates rises which are front loaded in Q1. The other 'villain' mentioned is rents and they're really soft atm, some landlords are actually retreating in their prices when their properties become vacant and there's no headroom to raise rents to cover the aforementioned rates rises, let alone insurance increases. The only avenue to cover these costs are reduced interest rates and a tax refund in 2025 due to the gradual restoration of interest deductibility. But from an inflation pov, rents are, at best, static and in some cases falling.
"the optics are bad"
Who the feck cares? We're talking about people's lives, jobs and marriages! (A loose quote from somewhere.)
The RBNZ likes playing god with the economy. They have tools. They haven't used many of them as yet.
Let's see how well they play god. I'm, for one, absolutely fascinated and disgusted in equal measure!
Hay Chris, I like your disdain for the superficial!
Putting aside Orr's massive ego; when the RB overcompensates in reacting to a problem that, let's be honest, they are largely responsible for causing, it resembles a car spinning out of control.
Making a cut of 75bp would look like a panic reaction and the economic ripple effect might not be benign.
T.A has the track record of a broken clock. He repeatedly said for 2022 onwards that prices would keep rising and encouraged people to 'buy now'. Many who took this advice are in negative equity. He is a self-absorbed snake oil salesman pushing his own narrative that he has a vested interest in. If you see him as worthy of actually absorbing his advice and repeating it to suit your own narrative, you may as well be slinging the snake oil yourself.
My comment was tongue in cheek, I’m neither with regards to my wants, I’m a home owner & susceptible to the wealth effect so I’m guilty of that…I also believe that housing being unaffordable is woeful for the next generation/s, & for our economy long term.
That being said I do think it’s cyclical & while they had a chance to slow down/disrupt the next up cycle they’ve now missed the boat & the wheels are in motion for another 7-10 year swing eh…but we won’t see 40% a year stuff again (I hope).
And yes…I have noticed a few regular commentators are more selective in the articles they choose to comment on 😂
Just out a few hours ago.......
House prices are showing "additional signs of stability" with a small average month-on-month rise last month, according to the Real Estate Institute (REINZ).
In September, the group's data suggests national median price decreased 2.3% year-on-year, from $799,000 to $781,000, and increased 2.1% month-on-month from $765,000.
It already seems to me that some folk appear prepared to believe that whacking interest rates back down as fast as possible will fix if not everything, then certainly a lot of things, and quickly.
Whacking interest rates back down as fast as possible will fix some things, but not quickly.
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