Independent economic researchers Capital Economics say it is 'increasingly clear' monetary policy tightening is doing its work and the rate-hiking cycle is already over, with cuts coming next year

The "now popular assumption" that global interest rates will be held "higher for longer" will prove incorrect as economic growth disappoints and price pressures recede, according to worldwide independent economic researchers Capital Economics (CE).

In a report issued ahead of our Reserve Bank (RBNZ) reviewing the Official Cash Rate on Wednesday, chief global economist Jennifer McKeown, senior global economist Simon MacAdam, global economist Ariane Curtis and assistant economist Lily Millard say that with previous interest rate hikes clearly weighing on credit growth and raising debt servicing costs, it seems very likely that a sharper slowdown is to come in advanced economies.

"Accordingly, with few exceptions, we think that the rate-hiking cycle is already over and see cuts coming next year. Meanwhile, a step-up in policy support looks set to deliver a modest cyclical recovery in China, but the revival will not be strong or sustained."

This view from the CE economists comes as here in NZ the timeframe for rate cuts from the RBNZ has been moving further out. ASB economists, for example have very recently shifted their view of the first cuts out from the second half of next year to early in 2025.

In wholesale markets, pricing now has the OCR still slightly higher than the 5.5% it currently stands at as late as November 2024.

The CE economists, talking about both the NZ and Australian economies, say that both have dodged a recession so far, "but we still consider it more likely than not that output will shrink across the second half of the year".

"With inflation softening and labour markets loosening, we expect both central banks to turn to rate cuts next year, the economist say.

"Most measures of underlying inflation in New Zealand are now weakening. However, with GDP growth holding up better than expected, we’ve pushed back our forecast for the first RBNZ rate cut to Q3 2024."

In terms of the global outlook, the CE economists say while recessions have not yet taken hold "to the extent that we had feared", this seems to reflect temporary factors including households running down their savings and producers working off backlogs now that shortages have abated.

"But none of those props will last and it is increasingly clear that previous monetary policy tightening is doing its work. Financial conditions have tightened dramatically and credit growth has weakened or even turned negative across advanced economies."

The economists say recent increases in energy prices will boost headline inflation in advanced economies a little.

"But we expect this impact to be easily offset by a continued reduction in core inflation. This is particularly true in the US, where a let-up in labour market tightness is already weighing on wage growth.

"Accordingly, we doubt that the Fed, the ECB or the Bank of England will deliver the final interest rate hikes that markets anticipate and the Fed is likely to cut rates far sooner than expected. Relatively sticky wage growth will mean that rates have to stay at their peaks for a little longer in Europe, but when cuts do come we think they will be more aggressive than is typically assumed.

"While aggregate consumer spending is holding up okay, our measure of interest rate-sensitive spending is already weakening and is set to weaken further. We still anticipate recessions across most of Europe and suspect that US GDP will contract too."

The economists expect a global economic expansion of 3.1% this year to be followed by below-trend growth of 2.5% in 2024 and a modest recovery in 2025.

"Most of the weakness will come around the turn of this year. Our projections are generally below consensus, with the exception of Russia. The key downside risk globally is that inflation persists for longer than we expect, forcing central banks to raise interest rates further. That said, it seems to us equally plausible that a sharp fall in inflation could provoke more rapid policy loosening, allowing some borrowers to sit out this tightening cycle altogether."

The CE economists gave these highlighted views of how they see things panning out around the world:

US – Although economic activity has been resilient so far this year, there is already evidence that activity is starting to weaken, and we expect the economy to experience a near recession later this year. This should help bring core inflation back to target by mid-2024, prompting the Fed to cut rates aggressively next year.

Euro-zone – We still think the euro-zone will experience a mild recession later this year. But the tight labour market and stickiness in core inflation mean that the ECB won’t start cutting rates until the second half of 2024.

Japan – Economic activity looks set to slow. But with some evidence that firms’ wage-setting behaviour is changing, we now think the BoJ will abandon negative rates and then Yield Curve Control by mid-2024.

UK – Although the cost-of-living crisis is coming to an end, the drag on real consumer spending, real residential investment and real business investment from higher interest rates will soon grow.

Canada – With high interest rates starting to weigh on activity, the risk of a mild recession has increased again.

Australia & New Zealand – Weak economic activity will prompt the RBA and RBNZ to cut rates next year.

China – A step-up in policy support should deliver a modest cyclical recovery in the near term. But various structural factors including demographics and global fracturing mean that a sustained turnaround is unlikely.

India – Growth will remain strong, but easing food inflation should allow for rate cuts next year.

Other Emerging Asia – The worsening inflation outlook means that central banks won’t cut rates until 2024.

Emerging Europe – Sharp falls in inflation mean that central banks in CEE will cut rates at a rapid pace.

Latin America – Central banks will continue to cut rates faster than in most other EMs in the coming quarters.

Middle East & North Africa – High oil prices will help lift GDP growth in the Gulf economies in 2024.

Sub-Saharan Africa – Tight policy and a tough external environment will weigh on growth across the region.

Commodities – Most commodity prices will struggle in the near term as economic activity slows in DMs and the US dollar remains strong. But oil prices will stay high, and most other prices should recover in 2024.