Economic pundits are in almost universal agreement that the Reserve Bank of New Zealand will opt for a 25 basis point hike in its monetary policy review on Wednesday, taking the official cash rate to 5%.
An increasing number of economists and traders think this hike could be the last, although the central bank is unlikely to signal if they share that view.
Financial markets have priced in a high probability of one more increase in May, or possibly July, followed by an increasing chance of a rate cut from October onwards.
The banking crisis in the United States and the weak December GDP data have caused traders to predict one less hike, on the basis that credit conditions have naturally tightened.
Hamish Pepper, director of fixed income at Harbour Asset Management, pointed to a 2019 paper by RBNZ which described how international financial shocks impact New Zealand.
The effects flow through three main channels: trade, financial markets, and economic uncertainty.
It was too early to tell what kind of impacts would be experienced through the first and last channels. However in financial markets, interest rates had declined around 50 basis points and the kiwi dollar had weakened slightly since Silicon Valley Bank collapsed in early March.
“All else equal, this is positive for New Zealand economic growth and provides an offset to the possible reduction in export demand,” he said.
“While NZ bank bond yields have declined by a smaller amount relative to interest rate swaps … the large drop in risk-free rates has meant that wholesale NZ bank funding costs have reduced.”
The stress in offshore financial markets would not be enough to spook RBNZ, however the hike next week may be the last before a long pause.
“There are clear signs from leading indicators that monetary policy is working and we think the RBNZ is very close to the end of its tightening cycle”.
Signs and portents
One difficulty with monetary policy is that it operates with a long lag time. This means the financial conditions being experienced today are a result of policy settings months ago.
RBNZ has been looking for strong evidence that rates are high enough to halt inflation, but knows it may not see significant movement until it has already passed that level.
Last week, ANZ’s business outlook survey showed early signs the tightening of monetary policy has been gaining traction in the real economy, with inflation indicators falling slightly.
The bank’s monthly survey of several hundred NZ businesses asks what they think will happen regarding business conditions, employment, inflation, and other issues.
In March, there were a mix of small rises and falls across activity indicators but most remained much lower than average.
ANZ chief economist Sharon Zollner said inflation indicators continued to inch lower, albeit “painfully slowly”.
“The headline inflation and pricing indicators eased a smidgen. Pricing intentions have turned downwards the most convincingly (while still being problematically high), but inflation expectations are finally starting to look as though they may have turned lower too”.
A net 83% of firms in the retail sector expect to raise their prices in the next three months, which was up compared to February but still well down from a peak of 96% nine months ago.
Economy-wide pricing intentions were unchanged with firms expecting to lift prices 3.4%, compared to 5.5% in March 2022. There was also a downtrend in businesses' expected costs in the next three months, with the economy-wide measure at 5.2%.
“The data imply that on average, firms continue to expect margin compression, given costs are expected to lift more than prices,” Zollner said.
RBNZ has pointed to corporate profits and worker wage growth as being responsible for a large chunk of inflation in 2022.
The survey showed firms were expecting to raise wages considerably less in the next 12 months than they did in the past year. Still, 84% of respondents expect to raise wages somewhat.
“The winter could expose a few more rocks as the wave of tourists depart. But for now, the slowdown is looking broadly in line with the Reserve Bank’s intentions”.
Grave expectations
ASB chief economist Nick Tuffley expects two more rate hikes but said there were signs that higher interest rates were already having the desired effect.
“The economy may be losing momentum faster than anticipated, implying monetary policy is now starting to bite hard. There is more policy impact to come: the average mortgage rate being paid is only about halfway through its climb from trough to peak.”
Westpac economists Kelly Eckhold and Michael Gordon think the next hike will be the last.
“We’re currently forecasting a peak of 5% for this cycle, though we acknowledge that the risks are skewed towards a higher peak than a lower one”.
Economists expect the economy and the labour market to slow during the year, but said so-called weakness “remains in the realm of the forecasts” while actual economic data has been fairly robust.
“Until the RBNZ gets clear confirmation that the economy is slowing, it will continue to emphasise the potential for further rate hikes.”
Recently, the central bank has signalled it is paying close attention to inflation expectations when making its policy decisions. This is because inflation has become embedded in the economy and is starting to look more like a wage-price spiral.
BNZ economist Craig Ebert said: “If there was a key message in the February Monetary Policy Statement, it was that the Bank is considering inflation expectations intently”.
The central bank will be displeased by the results of Friday’s ANZ-Roy Morgan consumer confidence survey in which inflation expectations rose to a nine-month high of 5.4%.
Zollner said consumers were the first to spot inflation coming in 2021 — beating the pundits — and expectations were important in a tight labour market as wage demands were being met.
Without more substantial evidence of an economic slowdown, the central bank will be unlikely to signal any pause in its inflation fighting plans.
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