RBNZ could move in November

ANZ Research has brought forward its forecast for interest rate cuts in New Zealand on the back of softer-than-expected second-quarter inflation data and softening activity indicators.

The Reserve Bank of New Zealand (RBNZ) is now expected to lower the Official Cash Rate (OCR) by 25 basis points in November, rather than in February. And the balance of risks around that is tilted towards an earlier cut (October), rather than later.

Beyond that, ANZ Research expects a steady run of 25 basis-point cuts at each meeting, until the OCR hits a terminal rate of 3.5 per cent.

On top of the RBNZ’s acknowledgement of emerging downside risks for activity earlier in July, the latest consumer price index data should alleviate concerns expressed in May about upside domestic inflation risks. There were plenty of details across the release showing inflation pressures are reducing.

There is an enormously wide gulf between the RBNZ’s May MPS forecast of no cuts until August 2025, and both market economists’ evolving forecasts and particularly current market pricing. But the RBNZ is not afraid to change its mind when the facts change.

Tonal shift

The RBNZ surprised markets and economists alike with the extent of the tonal shift at its July Monetary Policy Review.

Two particular comments excited markets. One was the “extent of [monetary policy] restraint will be tempered over time consistent with the expected decline in inflation pressures”.

Strictly speaking this is nothing new, as there was no mention of timing. But in the complicated dance between the RBNZ and markets, the dovish vibe matters enormously.

The second was that the Committee “discussed the risk that...tight monetary policy is feeding through to domestic demand more strongly than expected”.

The risks of sticky inflation were discussed too, to be fair, but the market has its dove-tinted glasses on.

The reason the market is gunning for imminent cuts is the fact recent activity, labour market, and to some extent inflation indicators have rolled over. Much of it is ‘second-tier’ data but the list is long, including ANZ’s own Business Outlook survey, Truckometer and card spending.

Unlike the market, ANZ Research still thinks an August cut is unlikely, given non-tradable inflation is still so high, and the RBNZ is unlikely to revise down its growth forecasts dramatically.

The committee could be ready to jump, but for now it seems likelier if the RBNZ is confident things are well in hand, it would use the August MPS to set up a cut in October or November. That would lock in most of the observed easing in monetary conditions, while giving the Committee options as it awaits one more read of gross domestic product and the Quarterly Survey of Business Opinion - as well as certainty the drop seen in the monthly indicators isn’t a short-lived reaction to the RBNZ’s hawkishness in May.

October is a clear possibility. The RBNZ prefers to deliver turning points at Monetary Policy Statements, where a full set of forecasts can provide the justification and set out the path ahead. But setting up a cut in the August MPS could tick that box.

The remaining tricky issue with October is CPI is out just a week later. That doesn’t rule out a move, but perhaps raises the hurdle a little.

By November, the RBNZ will know more about whether the rolling over in the soft data will stick, or whether there’s a temporary element of noise and possibly even residual seasonality.

The impact of tax cuts and other income-supplementing fiscal measures will be clearer, and inflation should be back within the RBNZ’s target band by then.

The desire for certainty needs to be weighed against causing unnecessary damage to the economy – an accusation one suspects would be levelled by most business owners at this point. It is the RBNZ’s job to be a bit paranoid about inflation, but it is also required to avoid unnecessary volatility in output and employment.

How far, how fast

A key question for the market is not only when the first cut will come, but how quickly and how far the OCR will ease. It’s difficult to take a strong view on this at present.

A forecast of 25 basis-point cut at each meeting until the OCR reaches 3.5 per cent seems pertinent for now. ANZ Research will reassess the medium-term outlook in mid-August.

If the data continue to head south, the odds will increase that the RBNZ will have to cut below its estimate of long-run neutral (2.75 per cent) in order to minimise an inflation undershoot, all else equal - which it never is.

The market is pricing a solid chance of a 50 basis point cuts in the months ahead, but large cuts are typically seen in response to sudden, large negative economic shocks, rather than just weaker-than-expected starting point data.

It could happen, of course, but would likely require significant downward revisions to the RBNZ’s growth forecasts.

Sharon Zollner is Chief Economist at ANZ NZ

This is an edited version of the ANZ Research report “NZ OCR Call Change: 25bp cut in November”, published July 17, 2024.