Rate cut next week? Economists call for Reserve Bank to move now - Inside Economics

Reserve Bank Governor Adrian Orr. Photo / Mark Mitchell

OPINION

Welcome to Inside Economics. Every week, I take a deeper dive into the economic news you may have missed. To sign up to my weekly newsletter, click on your user profile at nzherald.co.nz and select “My newsletters”. For a step-by-step guide, click here. If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.

Does the market meltdown change the game for RBNZ?

The global sharemarket meltdown across the past week might have made things easier for the Reserve Bank.

While markets have been betting on an August rate cut for some weeks it never looked like a realistic prospect - until now.

Whether it moved in August, October, or November, the RBNZ always had a huge pivot in front of it. RBNZ’s official rate track (released in May) still has its first rate cut pencilled in for August next year.

Unlike market economists, central banks don’t get to update these things whenever they see fit.

But, just to be clear, the current debate is about whether they’ll cut the OCR this August. That’s this August, the one we’re in now! It’s next Wednesday at 2pm to be precise.

So it’s a very big leap.

Until all the market turmoil unfolded I figured that leap between a forecast August 2025 cut and an actual cut in August 2024 was too big to make.

It may still be. But there is now a dramatic turn of events that the RBNZ can point to for the pivot. How dramatic is hard to say (especially when you’re writing to a deadline ahead of Wall Street’s opening).

It’s likely markets will be volatile for a while even if they rally short-term. The risk of further investor panic remains very real.

Yesterday both BNZ and Kiwibank economists piled pressure on the RBNZ by calling for an August cut. To be fair both BNZ and Kiwibank had already been arguing that we are overdue for a cut.

But the latest calls were more forceful.

“Overly restrictive monetary policy has inflicted much pain and tamed the inflation beast. Households and businesses are struggling,” wrote Kiwibank chief economist Jarrod Kerr.

“Almost all data have come out on the weaker side of expectations, and well below RBNZ estimates. Unemployment is rising, swiftly, and confidence in the economy remains at recessionary levels. It’s been two years of recession. Interest rate relief is required, now.”

Kerr described the RBNZ’s hawkish monetary policy statement in May as “a massive misstep in the wrong direction”.

“We recommend a cut next week, followed by a cut at every meeting until the cash rates hit 2.5%,” Kerr said.

BNZ head of research Stephen Toplis also called for “an immediate rate cut”.

“We strongly believe the Reserve Bank should be easing monetary policy as soon as possible. Indeed, we are on record as having said that it should already have done so,” he said.

“Given the lags between rate moves and their impact on the economy and the current parlous state of New Zealand, we strongly advocate that the Bank starts a progressive easing cycle from the August meeting.”

Will RBNZ cut though?

Neither Kerr nor Toplis is confident that the RBNZ will actually cut next week even though markets have it nearly fully priced in.

Kerr notes that market odds are now at 92% priced (as of Tuesday).

“And there is nearly 220bps of cuts priced to August next year (3.32%). The terminal rate has collapsed from 4% a few weeks back, to 2.95% today.”

Just before the big Asian market sell-off on Monday afternoon, Westpac economists brought forward their expectation for the first OCR cut to October and said they expected to see a second one in November.

“Recent data suggest that economic activity dipped more sharply than previously expected in the June quarter of 2024. This is evident in a raft of higher frequency indicators such as business and consumer confidence and the Purchasing Manager Indices.

“We think that GDP fell 0.6% in the June quarter. Given this weak performance, it looks likely that growth will continue to be subdued in the second half of 2024.

“Importantly, we now also see definitive signs that the labour market is adjusting more quickly to the weak growth profile that has been in place for some time. We now expect the unemployment rate to move more quickly to a higher peak of 5.6% in 2025.”

That’s bad news really - however much mortgage holders might be cheering for lower rates.

We probably shouldn’t lose sight of the fact that all this rate-cut talk is underpinned by fears about the state of the economy both here and around the world.

On that basis, I hope Westpac is right. A cut next week would be nice for mortgage holders. But getting there would likely require a horrible week for the global economy.

Did the Fed wait too long?

This week’s sell-off has certainly locked in a September rate cut for the US Federal Reserve. There is no shortage of financial commentators saying the Fed blew it by not moving last week.

Some have even suggested an emergency cut will be needed sooner than September. That’s possible if the sell-off keeps spiralling but also risks adding to the panic.

Whether the economic outlook in the United States has really changed that much in a week is debatable. Economist and New York Times columnist Paul Krugman reckons recessionary warning lights are flashing.

“The US probably (probably) hasn’t entered a recession yet. But the economy is definitely looking pre-recessionary,” he wrote on Tuesday.

“It’s already clear that the Fed made a mistake by not cutting rates last week; indeed, it probably should have begun cutting months ago. Unfortunately, we can’t turn back the clock. But the Fed’s open market committee, which sets short-term interest rates, can and should make a substantial cut — probably half a percentage point, rather than its usual quarter-point — at its next meeting, scheduled for mid-September.”

How significant is the market sell-off really? We won’t know for a few days yet.

But you could make the case that Wall Street investors just ran out of patience and threw a collective tantrum.

Unlike 1987 and 2008 there is little mystery to the underlying causes of this correction. Investors have been on edge for some time about the prospect of the Fed winning the inflation fight without causing a recession.

Did the Federal Reserve wait too long to cut interest rates?

Meanwhile, they’ve been piling into tech stocks on AI hype creating a precarious bubble in parts of the market. That combination created a tinder-dry bonfire that just needed a spark.

It got two.

A worse-than-expected US jobs report on Friday set recession fears alight. Meanwhile, a specific shift in the economic outlook for Japan saw a huge move in investor sentiment and caused the biggest one-day fall the Nikkei had seen since 1987.

It could have been worse. And of course, it might still be. There was really no way around a correction for tech stocks on the Nasdaq. But if we can get through that without the whole system crashing down then lower rates should start to buoy the rest of the market.

Here’s hoping.

Between the start of 2023 and their peak in June, shares in AI chip maker Nvidia rose by 740%. That kind of puts the 20% they’ve slumped in past two months into perspective.

It’s a reminder that unless you’re a trader it pays to take a long view of investing. Unless you are betting on the fall of modern civilisation then there is no reason to bet against markets. They consistently create wealth for investors. Just have a look at a graph of the S&P500 across 30 years (see below).

Look at the starting point, look at the endpoint, and rule an imaginary line between the two. That’s what most of us should be focused on. If you are a share trader, that’s different. But as Warren Buffett said this week: if you’re afraid of a market sell-off, you shouldn’t be trading shares.

Where does NZ’s total debt sit as a percentage of GDP

A reader of this week’s Nation of Debt feature asks: What has happened to our total gross national debt as a percentage of GDP?

For Nation of Debt we get a total gross debt figure by combining the latest Reserve Bank figures for private debt with Treasury numbers for Crown debt, Local Government Funding Agency data on council debt, and the IRD’s data on student loans.

This year that gives us a total of $827 billion in gross national debt.

We still focus a lot on net core Crown debt to GDP. That number has soared in the past few years. It is featured in part two of the Nation of Debt series by Jenée Tibshraeny. When we started the Nation of Debt feature in 2016 the net Crown debt to GDP was just 24% but after the period of borrowing and spending during the pandemic it is now 44%.

I hadn’t thought to look at the total gross debt figure as a percentage of GDP. But it is interesting - particularly when we look at how it has changed since 2016.

New Zealand’s most recent annual nominal GDP - to March 31 - is $410b. That gives us a gross debt-to-GDP ratio of 201%.

That’s pretty ugly. It illustrates why, even though our Crown debt ratio is relatively low, we still find ourselves in a precarious position with regard to overall debt.

Mostly it’s our mortgage debt, of course, owed to foreign banks and at $361b representing 44% of total debt (see graphic below).

I’ve never been shy of pointing out that our outsized private debt (and ongoing current account deficit) limits the government’s ability to borrow at levels that nations like Japan (which has net govt government debt to GDP of 168%) do.

But if we look at how the total debt to GDP ratio has shifted since 2016 it paints an interesting picture of how the composition of debt has changed.

Back then (the first quarter of 2016) GDP was $258b and our total gross debt figure was $492b. That’s a ratio of about 190%.

So unsurprisingly, our total debt as a percentage of GDP has risen. Perhaps what is surprising is that the increase seems relatively modest.

The reason for that has something to do with the craziness of the pandemic and its aftermath.

“The compositional shift from private sector to public sector debt is the big post-Covid theme,” says ANZ senior economist Miles Workman.

“Had fiscal policy been less pro-cyclical in recent years (i.e. the last Government repeatedly increased spending when there was no spare economic capacity to accommodate it), the RBNZ wouldn’t have had to hike the OCR as much as they did, and private sector credit would likely be a little higher today and public sector debt a little lower.

“In other words, because there was no economic resource to accommodate more demand from the Government (without adding to CPI inflation pressures), the RBNZ had to make room for the extra government spending by hiking the OCR more than otherwise – that has weighed on private sector credit.”

So if we look at data for household credit - generally mortgages and consumer debt - then we see that the ratio to GDP spiked in 2020 to a peak in 2021 as the housing market went crazy on stimulatory interest rates.

But it has fallen sharply since then.

Weirdly you could make the case that the composition of our national debt is looking more balanced these days. But it’s not a case I’d push too hard as nominally we are in more debt and we are vulnerable to another spike in private debt if house prices take off again.

As Workman pointed out in the Nation of Debt feature on Monday: “New Zealanders are just not very good at saving and our net external liability reflects that. We borrow a lot from the rest of the world.”

Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003. To sign up to my weekly newsletter, click on your user profile at nzherald.co.nz and select “My newsletters”. For a step-by-step guide, click here. If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.