Inflation earlier this year was higher than New Zealand's central bank and many consumers liked, but since then the Official Cash Rate and inflation have come down. Video / Alyse
Recently we made the case for a 0.75% cut at each of the two final Reserve Bank meetings of the year. This was a non-consensus call. Market expectations following last week’s Consumers Price Index (CPI) datahave clearly shifted in terms of what will happen at the November meeting.
The rate implied by markets is now ~4.2%. In other words, this suggests odds are split between a 0.50% or a 0.75% cut next month. In the space of a week, the prospect of a 0.75% rate next month has gone from what was seen as an outlier call to one deemed plausible.
A general comment by dissenters to such a big a cut is that large reductions are generally reserved for “extreme” circumstances. It can be argued we are in such circumstances now.
But even before that, it’s worth remembering the Reserve Bank’s (RBNZ) mandate was changed at the end of last year to a single operational objective of annual inflation between 1% and 3% over the medium term “with a focus on keeping future inflation near the 2% mid-point”.
Maximum sustainable employment is no longer an operational objective in the RBNZ’s remit. However, as a secondary objective, it seeks to avoid “unnecessary instability in output, employment and interest rates, and the exchange rate”.
The September quarter CPI release showed annual inflation running at 2.2%, down from 3.3% at the June quarter. Expectations were for a print of around 2.2%-2.3%, and for a change the miss to the bottom side was courtesy of lower non-tradeable (domestically driven) inflation, which is the lowest in three years, despite a surge in property rates.
There was the mitigating factor of a 22.8% fall in early childhood education fees (a result of the Government’s FamilyBoost rebate), but there’s no escaping that inflation pressures are moderating.
It is also worth highlighting that domestic inflation typically lags the labour market by about six months. Unemployment is rising, so inflation here might fall much faster yet. Meanwhile, annual tradeable inflation is now at -1.6%, with falling fuel prices a factor.
On a quarterly basis, CPI inflation was just 0.6%, at the lower end of expectations, and just 0.2% on a seasonally adjusted basis.
On an annualised basis, seasonally adjusted inflation is just 1.2%. Core inflation measures like the 30% trimmed mean and the weighted median, on a quarterly basis, slowed to the lowest level since 2020.
For the first time since March 2021, annual headline inflation is within the RBNZ’s target band. Inflation could now go through the bottom of the band due to the recession. Having landed on a 0.50% reduction last week, should the RBNZ now look to play catch-up and go with a 0.75% cut in November?
Inflation has fallen to within the bank’s target band at pace, and given the current downturn, it could undershoot and go right to the bottom of the band at 1%. It is therefore not hard to argue that we should be at, or below, the RBNZ’s “neutral” rate (neither boosting nor restricting growth) of 3.8% right now. The case for a 75-basis-point reduction in the Official Cash Rate (OCR) does seem legitimate.
The Reserve Bank under Governor Adrian Orr hiked interest rates to combat inflation, but in recent weeks the tide has turned. Photo / Mark Mitchell
The risk of undershooting inflation on the downside is especially possible in economies such as ours, which are facing numerous challenges and are effectively deflating.
Our economic data is dire, and the RBNZ should probably be pushing the panic button. The economy is in recession and unemployment on the rise. Various measures of confidence may be picking up, but from depressed levels, and are on the back of rate cuts – which take time to filter through the economy.
We’ve had further evidence of the challenges New Zealand is facing during the past week.
The BNZ BusinessNZ Performance of Manufacturing report showed while manufacturing activity ticked up in September, it remained in contractionary territory. It is the same for the services sector.
The PSI report showed the services sector still slowing and in contraction in September – for the seventh consecutive month. The service PSI employment index also reversed back to its lowest result since February 2022. We are something of an anomaly with the services sector, as many other Western countries are in good shape.
Key parts of the Kiwi economy do appear stuck in a rut, which therefore increases the need for extraordinary measures.
Meanwhile, there are some flashing red lights on other fronts. The growth outlook for China, our largest customer, remains uncertain.
Officials in China announced stimulus initiatives recently but there remain question marks, as also noted by the RBNZ, about their effectiveness, which poses downside risks to New Zealand’s real export growth, as well as to export and import prices.
Some other previous tailwinds are dissipating.
The migration boom appears to be petering out with fewer inbound arrivals, while the brain drain seems now to be running at a record pace (56,100 annually on a net basis).
The annual net migration gain in the year to August 2024 was 53,800, well down on the 67,200 in the July year, and less than half of the 127,700 in the year to August 2023. The long-term average for August years is a net migration gain of 28,200, so we are clearly above that – but the boom is dissipating.
Overall, migrant departures of 134,300 for the year are the highest on record. On a monthly basis, August had a 38% decrease in migrant arrivals and a 43% increase in migrant departures on a year ago. We have more Kiwis leaving in droves, and the number of non-New Zealanders arriving is falling. These numbers reflect an economy in a tough spot, and unattractive compared to alternatives.
Does all this mean officials should be forced into action stations now with a bigger rate cut?
Some good news is that a larger rate cut now will take less time to filter through to the economy than it did previously.
Devon recently attended a speech on the transmission of monetary policy given by RBNZ assistant governor Karen Silk, who said around 75% of new home loan flows currently carry interest periods of one year or less, and about 70% of existing home loans will be repriced within the next nine months.
There is something of an imperative with the central bank meeting on November 27, because officials do not have their next meeting till February 19.
That’s nearly three months in which a lot can happen to our growth profile, and not necessarily in a good way.
Apart from large companies, we meet and talk with a lot of smaller businesses, and it is clear many are struggling and some are even on the brink of failure. A larger rate cut this side of Christmas might make all the difference.
There are those that contend a large rate cut is not warranted, considering the Fed in the US is potentially looking to step down from the jumbo 0.50% rate cut when it meets next, after the US election.
But the US economy is growing at 3%, while New Zealand’s is contracting. The Fed also holds meetings in December and January.
With this backdrop, will last week’s inflation figure drive the RBNZ to cut rates by a thoroughly plausible 0.75%?
Or might it depend on more incoming data in the coming weeks – including select monthly price indices, labour market data and the September-quarter unemployment rate?
Or will the much-needed real jumbo cut be avoided altogether, to save an admission that the New Zealand economy is lagging many others, and that rates were pushed up too high too fast and kept there for too long? Time will tell.
