Policymakers at the Reserve Bank (RBNZ) thought seriously about lifting the Official Cash Rate (OCR) above 5.50% at their May meeting but opted to hold fire for now.
Governor Adrian Orr told reporters the RBNZ's Monetary Policy Committee gave “real consideration” to a hike and spent “a lot of time” discussing whether inflation was falling fast enough.
Progress on inflation has been disappointing the bank and pricing pressure in the short term appears to be surprisingly strong. However, the medium term outlook was more promising.
“Monetary policy is unambiguously restrictive … and the output gap is growing, so we know we are going to get there. That was the balance of risk, and we thought ‘no; patience still’, but that gives you a sense of the challenge around the table,” he said.
In the short term, the Reserve Bank is facing stubborn inflation, falling productivity growth, and uncertainty about when price-setting behaviour will return to normal.
The central bank lifted its projected OCR track from a peak of 5.6% to 5.65%, in a hawkish move that took markets by surprise.
Gareth Kiernan, chief forecaster at Infometrics, said this forecast track implied that another interest rate rise was “more likely than not before the end of this year”.
Stephen Toplis, BNZ’s head of research, said the higher track was a warning shot for those who thought rate cuts were on the way.
The retail bank has shifted its forecast for the first rate cut to occur in February 2025, instead of in November this year. The RBNZ’s own track suggests around August next year.
“Of great importance is the fact that the Bank no longer believes annual inflation will fall well within its target zone in the September quarter of this year,” Toplis wrote.
Forecasts in February projected annual inflation would be 2.6% in that quarter but the RBNZ’s updated numbers for May added forty basis points and brought the headline to 3%.
Despite everything
The delay in disinflation comes despite New Zealand being in a recession with economic growth well below trend and unemployment climbing.
Inflation forecasts have been revised up, even as economic forecasts have been revised down.
Kelly Eckhold, chief economist at Westpac NZ, said the worsening conditions were being cancelled out by lower estimates of the economy's productive potential.
Economic activity has been weak but New Zealand’s ability to produce output has also been falling, which means the demand and supply balance hasn’t changed as much.
It is the same for the Government’s upcoming budget. Whatever spending it includes will be more inflationary than might have been assumed a few months ago.
Kiernan said the lower potential output estimate had resulted in another increase in the estimated neutral OCR, by 25 basis points to 2.75%, but the RBNZ was still being too hawkish.
“In our view, given the clear stresses the economy is currently under from high interest rates and rising unemployment, and that monetary policy is clearly constraining demand, such an extended wait to start cutting interest rates is far too long,” he said.
Governor Orr said one factor in not raising rates was that sectors sensitive to policy changes were mostly not seeing inflation, while less-responsive sectors still were.
Lifting the OCR may only serve to add pressure to already struggling sectors, such as construction, while the problem areas don’t react to the policy change for many months.
Things such as insurance, household energy, and property rates were all adding to headline inflation but were slow to respond to higher interest rates.
“Eventually monetary policy will win the day but they are just less sensitive,” Orr said.
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