Strong economic growth lifts odds on another OCR hike

Mortgage rates may rise again as the economy stays stronger than expected.

Good news - the economy is not in recession. Bad news - stronger growth probably means mortgage rates going higher.

They don’t call economics the dismal science for nothing.

The economy grew 0.9 per cent in the second quarter, exceeding expectations. GDP rose 3.2 per cent in the year ended June 2023, Stats NZ said today.

Revisions to the data for the December 2022 and March 2023 quarters mean the economy likely never was in recession through that period.

But the stronger economic growth path also suggests the Reserve Bank faces a tougher challenge to quell excess demand and get inflation back into the 1-3 per cent target band.

Strong net migration buoyed the numbers but the better than expected performance from sectors like manufacturing meant growth remained marginally positive even on a per capita basis.

“Business services was the biggest driver of economic growth in the quarter,” Stats NZ said.

Although several other industries also contributed strong results, including: public administration, rental, hiring, and real estate services.

Transport equipment and machinery manufacturing drove higher activity in the manufacturing industry in the June 2023 quarter.

Manufacturing activity increased after five consecutive quarters of decline.

Debt markets reacted swiftly to the news, two-year swap rates rose from 5.66 per cent shortly before the news at 10.45am to 5.76 per cent afterwards - implying the market sees another hike to take the Official Cash Rate from its current level at 5.5 per cent to 5.75 per cent.

“The unexpectedly strong rebound in growth last quarter means that the RBNZ’s next meeting in October will be a live one,” said Abhijit Surya, at Capital Economics.

“Given how noisy the recent activity data have been, it is difficult to definitively parse the implications for monetary policy. However, we now think that risks are tilted towards further rate hikes.”

Westpac’s Darren Gibbs also noted that the data would impact the RBNZ’s estimate for the output gap in the economy, adding to the likelihood that it would “need to act on the slight tightening bias that it indicated last month”.

ANZ economists, who have long forecast that another hike would be needed in November, agreed.

“We don’t think today’s data are a game-changer for the October [4] Monetary Policy Review (we expect a hold), but it certainly increases the likelihood that the discussion takes a hawkish tilt,” said senior economist Miles Workman.

However, by the time we got to the crunch in November, the third-quarter inflation and labour market data would matter a great deal more than this GDP number, he said.

Even if the OCR doesn’t rise again, the economic strength suggested rates would need to stay at elevated levels for longer, said ASB economist Nathaniell Keall.

“The RBNZ has signalled a high hurdle to further OCR moves in either direction, and most forecasters still expect New Zealand’s growth to slow from here,” said Keall.

“The RBNZ will be watching more timely indicators over the coming weeks and months.

“At the least, the continued resilience in activity highlights the risk that OCR settings will need to remain tight for a prolonged period to get inflation back into target.”

Adding to the upwards pressure on retail mortgage rates, the US Federal Reserve last night indicated it could hike its interest rate one more time and is likely to keep rates elevated for an extended period.

This pushed up US Treasury yields, which have an impact on the international borrowing costs for local banks.

US short-term Treasury yields rose 5-10 basis points after the decision. Two-year rates are now at their highest level since 2006 (5.16 per cent).

Economists had expected the second-quarter bounce in GDP, although it came in stronger than the market and the RBNZ forecasts of 0.5 per cent.

ASB’s Keall described the rise as “meaningfully stronger than expected”.

“Net migration figures continue to prove strong and may be continuing to prop up growth on a headline basis,” he said. “On a per capita basis, GDP rose a more meagre 0.2 per cent over the quarter.”

But many economists expect rising interest rates and low export prices could lead the country to slip back into recession later this year or early next.

“The New Zealand economy continues to prove more resilient than expected, but we continue to expect growth to slow over the next 12 to 18 months,” said Keall.

BNZ head of research Stephen Toplis was unimpressed by the headline number.

“If we ignore all the Covid noise this is the weakest performance by this economy since Q2, 2011,” he said.

“But it’s going to get a lot worse. We are forecasting zero change in activity for Q3. That will take annual growth to just 0.3 per cent. We do not expect annual growth to exceed 1 per cent again until Q4 2024. On a per capita basis this is simply awful given that population growth is now over 2 per cent per annum.”

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.