BNZ economists say the Reserve Bank's next move is likely to be heavily influenced by its assumptions of the supply and demand impacts of a net migration inflow that is 'much stronger than anyone believed'

The Reserve Bank’s next move is highly likely to be heavily influenced by its assumptions around the relative supply and demand impacts of a net migration inflow that is much stronger than anyone believed, BNZ economists say.

In a preview of next week's Reserve Bank (RBNZ) review of the Official Cash Rate (OCR), BNZ's head of research Stephen Toplis said with migration comes extra demand for housing and goods and services.

"Higher demand, all other things being equal, means higher inflation. Exactly the opposite of what the RBNZ needs."

The OCR is currently at 5.25%, having been raised some 500 points by the RBNZ since October 2021 as our central bank tries to rein in inflation, which at an annual rate of 6.7% as of the March quarter was still well outside the targeted 1% to 3% range.

Toplis is picking another 25 point hike by the RBNZ at the review on Wednesday, May 24.

And most commentators have been expecting the RBNZ to raise the OCR by a further 25 points to 5.5% - with this then being the peak of this hiking cycle. However, Westpac economists broke out from the consensus this week, picking that the OCR will need to be raised to 6% and citing the demand impacts of the sudden surge of inbound migration in NZ. 

Toplis saw "some irony" in the current migration situation.

"The theme of the day for some time now has been how do we increase the supply of people to contain the inflation that is being driven by an excessively tight labour market? We appear to be achieving this in spades. Anecdotally, the ease of finding labour is improving rapidly. The pressure is starting to come off. Sure, employment growth in the March quarter, of 0.8%, was well above expectations but this demand for labour was clearly offset by the increased supply."

Toplis said some commentators seem to have focused more on the demand side of the balance sheet from migration rather than the supply side and now see the OCR headed significantly higher in a bid to offset the extra inflationary pressure generated.

"Such an outcome should not be ruled out but we are not convinced that we know enough yet to see that as a central scenario."

He said a big question was how permanent is the current surge in net migration?

"How much is simply catch up from the period of effective border closure? If it’s pent-up migration then the flows could quickly return to manageable levels. If not, then we are highly likely to have an inflationary problem."

But Toplis questioned whether the government would allow migration to remain so high if it did become clearly inflationary, or would the government simply tighten its migration settings.

"Surely tightening settings would be a better way to handle the situation than forcing monetary policy to handle any excesses that develop."

Where all this ends up is a moot point, Toplis said, "but it does seem to us that the surge in migration is already having an impact on demand".

"House prices appear to be stabilising and, anecdotally, there is a tangible migrant presence in the market. The impact of migrants on the market should, in the first instance, be lower than in the period immediately pre-Covid as the supply of housing is now strong, interest rates are much higher, and investor demand is weak. So, for now at least, migrants appear to be helping prevent a further fall in house prices rather than generating excess demand.

"The other area where migrant demand appears to be showing up is via the ongoing strength in consumer spending which has, so far, defied what one might expect to see under such tight monetary conditions. The sheer extent of the current population increase means that per capita spending would have to fall significantly to generate a decline in spending at the aggregate level."

Toplis said the decision-making process for the RBNZ "is not getting any easier".

"Since the surprise 50 basis point hike at its April 5 meeting there has been a swathe of data suggesting such a hike was unnecessary. But, on the flip side, there have also been developments indicating inflationary pressures might be even higher than the Reserve Bank had anticipated when it made that aggressive decision."

Toplis said there is "enough dispersion" in recent economic data that the Reserve Bank could make any number of decisions based on the weightings that it chooses to ascribe to the various available indicators.

He said if you were to look at the varying list of economic factors in isolation "then there would be no need for any further rate increases".

"Our expectation, subject to any shock from the Budget (which is entirely possible), is that the Reserve Bank will hike a further 25 basis points and leave a modicum of upside in its future track to provide the clear message that it could go again if necessary. At the same time, we expect the Bank to water down any thought that rates could fall anytime soon by printing a [forecast] rate track with no decline in rates until well into 2024. For all intents and purposes this would be very similar to the profile the Bank produced back in February."