Where NZ wholesale interest rates and the RBNZ go their separate ways

The market is parting company with the Reserve Bank on the future path of interest ratse. Photo / File

New Zealand wholesale interest rates are lining with the Reserve Bank’s view, but only up to a point.

The central bank’s forecasts, published in November, have the official cash rate (OCR) hitting 5.4 per cent next year and remaining around that level for two years after.

Wholesale interest rate pricing doesn’t have problem with the OCR exceeding 5 per cent next year.

However, how long it spends at that point is where the market and the Reserve Bank part company.

“There is a disconnect between what the Reserve Bank put out in its November forecast and where the market has the implied OCR to be,” Harbour Asset Management’s fixed income and currency strategist Hamish Pepper said.

“The market probably has more belief that monetary policy is working quite effectively to take pressure out of the economy and to bring inflation back to the target.

“It does not buy into the idea that you need to keep policy as tight for as long,” he said.

Inflation in the September year came to 7.2 per cent - well beyond the Reserve Bank’s target range of 1 to 3 per cent.

The Reserve Bank has the OCR reaching 5.3 per cent by the end of 2024 while market pricing has 4.6 per cent.

“It’s a decent difference and I think there is a message there,” Pepper said.

In the swaps market, short-end rates continue to exceed longer end rates - a fairly reliable indicator that an economic downturn is on the way.

Pepper said there were questions as to how severe the downturn would be and he doubted a Global Financial Crisis-style recession was on the cards.

“It’s not a particularly strong or severe recession that is being anticipated here,” he said. “Maybe we need more evidence of it before we can price it in.”

Much would depend on the extent of the downturn in the real estate market.

Pepper suggested a price decline of 30 per cent or more in housing from its peak could be a “channel” for a more severe downturn.

In November, the Reserve Bank raised its official cash rate from 3.5 per cent to 4.25 percent.

“The [monetary policy] committee agreed that the OCR needs to reach a higher level, and sooner than previously indicated, to ensure inflation returns to within its target range over the medium term,” the bank said then.

In a commentary, Harbour Asset Management said despite a significant upside surprise in GDP for the third quarter, more recent indicators of economic activity suggest the Reserve Bank’s measures are having their desired effect.

GDP grew 2.0 per cent quarter on quarter in Q3, well above the Reserve Bank’s estimate of 0.8 per cent with a large pickup in tourism driving those gains.

“The detail, however, showed monetary policy at work. Household consumption fell 0.1 per cent quarter on quarter, after a 3.4 per cent drop in Q2,” Harbour Asset said.

“Following an aggressively hawkish November decision by the RBNZ, where it hiked 75 basis points (having considered 100bp) and lifted the OCR forecast path by 140bp, survey data for December have been dreadful.

“Consumer and business confidence are at all-time lows.

“Firms’ outlook for their own activity is consistent with recession. Even the labour market is showing early signs of easing with a sharp drop in employment intentions and job advertisements,” Harbour Asset said.

“But this is what the RBNZ wants, to drive the economy into recession such that inflation returns to target and the labour market to equilibrium.”