David Hargreaves says we should see another decent-sized cut to the Official Cash Rate in the coming week, but beyond that, all eyes will be on how the Reserve Bank sees things developing next year

What's it to be then? Small? Large? Or medium?

I'm talking of course about the possible size of cuts to the Official Cash Rate (OCR).

On Wednesday, November 27 the Reserve Bank's Monetary Policy Committee headed by Governor Adrian Orr makes its final OCR call for 2024, with the next decision after this one not due till February 19, 2025.

There seems virtually no chance that the RBNZ will leave the OCR unchanged, so logically we are looking at a choice between a 25 basis point cut, a 50, or a 75. 

Most money's now on a 50 (the medium option). 

So, if we do accept that 50 will be the choice, taking the OCR down to 4.25%, what else should we be looking for in this latest review by the RBNZ? 

Well, this one's accompanied by a new Monetary Policy Statement (MPS) - the first since August. This means the RBNZ will be dusting off its forecasts and coming up with some refreshed ones. 

And while it might seem odd for me to relegate the significance of a cut that's likely to be as large as 50 points, the new forecasts are going to be very important.

These forecasts will be our window into the RBNZ's thinking for 2025 and then beyond. Crucially we'll be able to get a steer on the RBNZ's view of inflation in the coming year and therefore how much further the central bank will be minded to keep cutting interest rates and at what pace. 

At this point, let's take a few moments to remember where we've come from with all this and how we got here.

Starting with an emergency cut

The potted history is that in March 2020 the RBNZ made an emergency cut to the OCR as the pandemic took off, and dropped the OCR to a historic low of 0.25%. In 2021 inflation started to rocket, eventually reaching 7.3% by mid-2022.

In reaction to the hot inflation, and to take heat out of the economy, the RBNZ started hiking the OCR in October 2021, moving in increasingly bold steps (there was a jumbo hike of 75 basis points in there at one stage) to take the OCR all the way up to 5.5% by May 2023. And then the RBNZ holstered its guns and waited, and once it was confident inflation was on the run it started to cut. This was in August 2024 and we've seen 75 basis points worth of cuts so far, with the OCR currently standing at 4.75%

So that's where we are. Where are we going?

Market observers and economists seem to have somewhat pulled back in recent weeks from expectations (indeed, even exhortations) that the RBNZ should and will pull the OCR down rapidly.

The problem is that the global economic picture for next year is actually looking pretty murky. The prospects of rekindled global inflation are being mulled. And economists are now increasingly of the view that the RBNZ's approach next year will be much more measured. 

So, any light the RBNZ can throw on the issue in its forthcoming MPS will be most welcome.

But, anyway, let's not completely ignore the OCR decision itself in the coming week.

In order to try to understand what the RBNZ's about to do, we need to have a look at what's been happening in the big wide world of the economy since the RBNZ last reviewed the OCR.

A week after the last OCR decision on October 9, Statistics NZ released Consumers Price Index figures for the September quarter. These showed annual inflation dropping to 2.2% from 3.3% in the June quarter, meaning that it had gone back into the officially targeted range of 1% to 3% for the first time since mid-2021.

In its most recent set of forecasts, in the August 2024 Monetary Policy Statement (MPS), the RBNZ forecast annual CPI inflation of 2.3% for the September quarter. So, the actual figures were lower than the RBNZ expected.

Moving in the right direction

Additionally, the RBNZ had forecast the annual rate of the so-called 'non-tradables', (basically domestically attributed) inflation to be 5.1%, but it came in at 4.9%. That's still too elevated for the RBNZ to feel totally comfortable about it, but it is now moving in the right direction.

So, that was good for the RBNZ. Subsequently, Stats NZ's Selected Price Indexes, which include food, rents and altogether items that make up about 45% of the Consumers Price Index, showed benign inflationary pressures for October.

Unemployment was up to 4.8% in the September quarter from 4.6% in June. That was a little lower than the RBNZ's 5.0% forecast, but the figures also showed a significant fall in the 'participation rate' - those in the workforce. So, there was nothing in the unemployment numbers to concern the RBNZ.

Somewhat less benign, and surprisingly so, I would say, was the latest quarterly Survey of Expectations, compiled for the RBNZ. This survey asks business leaders and professional forecasters for their views of where inflation will be in: A year, two years, five years and 10 years.

While all of the results indicated future inflation of 2 percent-ish (which is what the RBNZ wants to see) all of the timeframes other than the one year (which is the one that obviously is always going to be closest to what actual inflation is doing) showed increases from the previous survey.

I didn't expect that. And maybe the RBNZ didn't either. Even if the increases were not huge - ranging between 9 and 17 basis points - they were increases. And those results were before the election of the next Trump administration in the US, an event that certainly could have impacts on worldwide inflation.

Following on from the Survey of Expectations, we had the RBNZ's Household Expectations Survey - and the results again would not have been what the RBNZ was looking for, with households expecting inflation to be 3.7% in two years' time - which is a higher pick than the same survey produced last quarter.

The importance of all this is that expectations of rising future inflation can easily become self-fulfilling as people increase prices in expectation that prices will go up. The RBNZ doesn't want to see people expecting the rate of inflation to increase.

So, all a bit of a mixed bag for the RBNZ to digest.

How the RBNZ manages all this as it now reduces the OCR is a delicate balancing act.

The cuts have been bigger

The cuts already made by the RBNZ have already been of a greater magnitude than the central bank indicated it would make in its last set of forecasts in August. The RBNZ wasn't forecasting the OCR to be where it is now till the March quarter of next year, while the OCR was only forecast to drop below 4% in the December quarter of next year.

Wholesale interest rate markets have been much more aggressive in the pricing in of cuts - at one point giving a better than one-in-three chance that the RBNZ will cut the OCR by 75 points next week. However, the pricing has moderated more recently and at time of writing the markets are very much pricing in a 50 point cut. 

And interestingly, the markets' previous collective conviction that another 50 point cut will be forthcoming in the February review has softened somewhat, though a 50 point move is still heavily favoured. 

Where does this all leave us? 

Well, the easiest option for the RBNZ appears to be a 50 point cut on the coming Wednesday. With the markets overwhelmingly expecting a 50bps reduction, such a drop will cause the least market reaction. And the RBNZ may want to avoid much of a market reaction.

For now homeowners and would be homeowners can enjoy some Christmas cheer that rates are coming down - and banks will likely quickly pass on at least some of a 50bps cut.

Then the RBNZ has the best part of three months to enjoy summer and contemplate the next move. Dropping the OCR quite swiftly thus far from the very restrictive 5.5% level has been the relatively easy bit. Next year the moves will need to be very carefully choreographed.

I'll leave you with these thoughts from Kiwibank's chief economist Jarrod Kerr and economist Sabrina Delgado:

"It’s a long time until we hear from the Reserve Bank again. Practically a whole season of waiting until their next rate decision in February. And a lot can happen between now and then. By then, we will have had a completely refreshed suite of data on economic activity, inflation and the labour market. Not to mention a Trump inauguration and God knows what else. But for now, if the data plays out how we expect it to, then we still think another 50bps cut in February should be delivered. With the 2% target inflation rate well within reach, we believe the RBNZ needs to get the cash rate below 4% ASAP. So why not get it to 3.75% in Feb?"

*This article was first published in our email for paying subscribers first thing Friday morning. See here for more details and how to subscribe.