Westpac economists have changed their call on interest rates and now predict the Official Cash Rate will be cut twice more this year - but they say there's even a chance there will be three cuts.
And they say more cuts could lead to more activity in the housing market and might lead to them raising their already bullish forecast of house price rises of 7% in the next year.
Westpac chief economist Dominick Stephens says he now expects that the Reserve Bank will cut the OCR in August and again in November, taking the OCR to an all-time low of 1%.
"And the risk to our new call is skewed towards earlier and/or more aggressive cuts – there is a possibility that the RBNZ could cut the OCR in September, and even a possibility that the OCR could drop below 1%."
Previously Westpac economists had forecast that there would be a cut next month - but no more. At the moment the OCR is at 1.5%.
Stephens said one possible catalyst to a September OCR cut could be adverse news on the labour market.
"If the RBNZ does cut in September due to rising unemployment, then there is a chance that they could go even further by cutting the OCR to 0.75% in November. However, at this stage we view earlier or more aggressive OCR cuts as a risk scenario – our central forecast is an OCR low of 1% delivered in November."
Stephens said the Westpac economists had been pointing out for some time that lowering interest rates will have consequences for asset markets, particularly house prices.
"In May we predicted that nationwide annual house price inflation would accelerate from 2% now to 7% over the year ahead, partly due to the mortgage rate declines already seen.
"Recent data supports our view. Over the past two months, we estimate that seasonally adjusted housing market turnover has risen 10%. Brisker house sales are a reliable sign of price rises to come."
Meanwhile, he said, New Zealand appears to be in the grip of a “search for yield” investment environment more generally. [Note: Westpac's own spectacular success with a bond offer this week would appear to demonstrate that point.]
"Growth in bank deposits has been weak, as people have been turned off by low interest rates. Meanwhile, share market prices have risen very sharply, particularly for dividend-paying stocks, and we have heard anecdotes that fund managers are seeing an influx of investment funds.
"We think investors seeking yield will soon turn to the slower-moving housing market.
"We will reassess our house price forecasts we when release our next Economic Overview in August. However, if we are right about the Reserve Bank cutting the OCR to 1% this year, then we can expect even lower fixed mortgage rates.
"That could prompt us to upgrade our house price forecast.
"Rising house prices will tend to stimulate more consumer spending. On top of that, we are still expecting the large doses of government spending that have been administered over the past two Budgets to stimulate the economy. True, there has been little impact from the fiscal stimulus to date, but that is probably just a matter of timing – it always takes a new government time to get the wheels of the bureaucracy turning in the direction it wants."
Stephens said a slowdown in the New Zealand economy has been in train for almost two years now, "and was well forecast by us".
"The wind down of the Canterbury rebuild and slowing house price growth were predictable, and caused the slowdown in GDP growth that we anticipated. But we previously expected that the economy would be picking up by mid-2019, on the back of fiscal stimulus and lower interest rates.
"Instead, recent data suggests that New Zealand economic growth has remained slow."
Stephens said in addition to weak domestic economic growth, there were now the first cracks emerging in the previously-robust export sector.
"Some sectors are still booming, but dairy auction prices fell 8% over May and June, prompting us to lower our farmgate milk price forecast to $6.90/kg (previously $7.20). And over the past month, there has been a 25% drop in export log prices. Forestry accounts for only 9% of our merchandise exports, but it is disproportionately important for the economic cycle due to its impact on employment.
"When log prices drop, forest owners often stop harvesting, with an immediate impact on employment and on the health of forestry contracting businesses. After the last log price downturn, in 2014, employment in the industry fell by 700 jobs. Other workers went onto reduced hours (and presumably reduced incomes). And of course, work for businesses involved in transporting forestry products and other related industries dried up, with an unknown impact on employment. This time could be similar."
Stephen said "to cap it all off", the trade-weighted exchange rate has risen about 3% over the past month, and is now about 1.5% higher than the forecast that underpinned the RBNZ’s May OCR decision.
"A higher exchange rate, if sustained, will compound the emerging concerns for some exporters and will suppress inflation by making imported products cheaper."
Stephens expects that on the back of the monetary and fiscal stimulus he's forecast, that economic growth will recover over the year ahead.
"This would preclude further OCR cuts in 2020.
"Indeed, we expect the Reserve Bank will be slowly hiking the OCR again in the early 2020s, although our tentative start date for OCR hikes is now mid-2021. That is later than previously forecast, because interest rates are going to have to stay low for longer than previously thought in order for the Reserve Bank to achieve its inflation and employment targets."