Softening house prices will 'cool urgency' for larger interest rate rises, Westpac economists believe

Westpac economists still see the Reserve Bank raising interest rates with "measured steps" rather than "large bounds", despite the RBNZ suggesting last week it may well consider some larger jumps in the Official Cash Rate.

The RBNZ raised the OCR by 25 basis points last week to 1%, but suggested the 25bps call had been "a finely balanced decision" and sad it was "willing to move the OCR in larger increments if required over coming quarters". That's already been interpreted in some quarters as preparing the market for a 50 basis-point hike in May.

But in Westpac's Weekly Economic Commentary, senior economist Satish Ranchhod said with the housing market cooling and Omicron spreading across the country he expected the RBNZ would just move in 25 basis point steps.

"...Even though we’re forecasting a series of OCR hikes, we’re not ready to jump on board with the extent of increases that are factored into the RBNZ’s projections. Instead, we’re continuing to forecast that the OCR will rise to a peak of 3% next year," he said.

The RBNZ is expecting the OCR may rise to 3.3% by next year and then to go even slightly higher - to 3.4% through 2024 and into 2025.

"A key reason why we differ from the RBNZ is what’s happening in the housing market," Ranchhod said.

"We’ve always put more weight than the RBNZ does on the role that interest rates play in house price cycles. And on this front, we’re already getting evidence that current mortgage rates (along with the recent tightening in lending conditions) are having a cooling effect on the housing market. Since November sale prices have fallen by around 2% and sales numbers are now running at below pre- pandemic levels.

"We’ve long forecast a cooling in the housing market in response to higher interest rates. However, the pullback that we’ve seen in recent months has been sooner than even we expected. That’s important as the housing market is a key influence on households’ wealth and their willingness to spend, and ultimately the extent of demand-side inflation pressures. That in turn could affect the extent of OCR hikes that will be needed to keep inflation in check.

"With mortgage rates set to continue rising, we’re forecasting house prices will fall by 5% over the course of this year, with a similar fall expected in 2023," Ranchhod said.

He said given Westpac economists' differing views on the peak in the OCR track to the RBNZ, "that raises the question of tactics".

"While the RBNZ has emphasised its willingness to move in larger steps, we still think their goal can be achieved in a series of measured 25bp hikes. Further evidence of a slowing in the housing market over coming months is likely to cool some of the urgency for bigger moves," he said.

In addition, the near-term outlook for activity had been "muddied" by the rapid rise in Omicron infections.

"In light of the experience overseas, it’s likely that we’re in for a period of high worker absenteeism. We’re also likely to see disruptions to the availability of some goods, as well as general nervousness among businesses and households that is likely to weigh on demand, especially in the hospitality sector. There may well be some price rises for hard-to-get items in these circumstances, but this should not be mistaken for ‘inflation’, in the sense of an ongoing process of generalised price increases," Ranchhod daid.

ASB chief economist Nick Tuffley said in ASB's Economic Weekly that it was "very noteworthy" that the RBNZ saw a 25bp vs. 50bp increase as “finely balanced”.

"The RBNZ was more concerned that high rates for actual inflation could become engrained into people’s expectations of where future inflation will track, a development that would make the RBNZ’s job of containing inflation harder," he said.

The probability of a 50bp increase at some point this year was therefore "real", should the RBNZ feel it is getting behind on its job of containing inflation.

"But nothing is simple at the moment," Tuffley said.

"The war in the Ukraine will boost NZ inflation slightly further in the short term through higher fuel prices, compounding the RBNZ’s concerns about people’s inflation expectations.

"Yet the war and its ramifications could escalate from here. And NZ is just now (rapidly) entering the disruptive and challenging part of its Omicron wave.

"[So] 25bp OCR lifts seem the most likely moves for the next RBNZ meeting or two."

Kiwibank economists too, in their weekly First View publication said while the RBNZ has kept open the door to larger hikes in the future the Omicron outbreak and housing market outlook "should keep them from crossing the threshold".