The Reserve Bank could lift the Official Cash Rate one more time early in 2024

The Reserve Bank of New Zealand (RBNZ) remains confident the Official Cash Rate (OCR) is high enough to quell inflation, but acknowledges a greater chance that one more hike may be needed.

The central bank’s Monetary Policy Committee voted unanimously to keep its base interest rate unchanged—at 5.50%—during its August meeting. 

However, projections released alongside this decision, in the August Monetary Policy Statement (MPS), showed the likelihood of another 25 basis point lift was increasing. 

The closely-watched OCR track was nudged up 10 bps, to 5.6%, and was forecast to stay at that level for three months longer than in the previous policy statement, released in May. 

Kelly Eckhold, the chief economist at Westpac NZ, said this was equivalent to a 40% chance of one more rate hike bringing the OCR to 5.75% in the first half of 2024.

One reason the central bank sees a higher chance of a hike was because it had revised its estimate of the neutral interest rate, at which the economy was neither suppressed or stimulated. 

The long-run neutral rate was revised up 25 bps to 2.25% in the August MPS. 

“This means that the RBNZ now believes that the OCR has not been constraining activity to the extent they had thought, and rates therefore need to be higher,” Eckhold said in a note. 

Red hot core 

While annual headline inflation has dropped from 7.3% to 6% in the past 12-months, underlying core inflation has been much harder to budge.  

Non-tradable inflation only peaked in the March quarter of 2023 and it was still running at an annual 6.6% in June. RBNZ’s sectoral factor model has been stuck at 5.8% for nine months.

Paul Conway, RBNZ’s chief economist, said there were a range of core inflation models and there was a divergence between them — although they were all higher than ideal. 

“We don’t put a huge weight on any one in particular, we take the suite of measures as giving us a distribution of what is likely to happen in core inflation,” he said. 

Meanwhile, inflation data has been forecast to be hot in the September quarter because of increased local government rates, higher insurance costs, and rapidly rising petrol prices. 

RBNZ expects quarterly inflation to lift to 0.9% in that three month period, up from 0.5% in the June quarter. The annual inflation rate would remain at 6%, in that scenario. 

Stephen Toplis, head of research at BNZ, said this persistent inflationary pressure could be behind the increase in the OCR track. 

However, this doesn’t mean the central bank has lost confidence in the inflation outlook.

“Governor [Adrian] Orr noted in his press conference that the rate track is model-driven and that there was no signal in the published shift,” he said. 

In the conference, Orr said there shouldn’t be too much focus on the slight increase in the OCR track from 5.5% to 5.6%. 

“Ten basis points is absolutely lost in the wash of the uncertainties you deal with in these monetary policy projections,” he said. 

“We are where we are and we’ll be watching the information as outlined. We are in a good position to go left or right depending on which way we need to as the data unfolds”. 

Hawks swoop regardless

However, traders in financial markets took the statement as slightly hawkish and bid swap rates and the NZ dollar higher. 

The kiwi dollar had been trading below US59.5 cents on Wednesday morning, but it lifted to almost US59.7c after the MPS was released. 

Sharon Zollner, chief economist at ANZ, said higher interest rates could provide some support to the struggling NZ dollar which has fallen 6% against the US in the past month.  

“[But it] pales in comparison to global concerns that are feeding the risk-off vibe in markets, and the RBNZ’s tone is unlikely to materially alter the path of the NZ dollar,” she said in a note. 

These same global concerns pose a split screen challenge for the Reserve Bank’s efforts to smooth out the economic cycle. 

In the short-term, inflation risks skew upwards, due in part to rising petrol prices and a stubbornly strong labour market, but the long-term risk swings in the other direction. 

Economic conditions have been deteriorating globally and that slowdown has been flowing through to the New Zealand economy. 

Eckhold said challenges in China’s economy were particularly problematic for New Zealand and could push the Reserve Bank to cut rates sooner than it currently expects. 

“Indeed, following last night’s auction, current dairy prices appear about 10% weaker than the Bank’s assumed cycle low point,” he said. 

Zollner said China’s cautious consumers and stalling construction industry was impacting prices for NZ’s key exports, namely dairy, meat and logs.

The Monetary Policy Committee said it had discussed risks around the outlook for global growth and judged they were “skewed to the downside”. 

Soft-landing still on

However, Orr said the economy was still on track for what economic commentators refer to as a soft landing. 

“If we can have a stable level of economic output, employment remaining at these very high levels, and have disinflation happen; that is a soft landing,” he said. 

RBNZ thinks the NZ economy will grow half a percent in the June quarter but then give most of that growth back in the September and December quarters (a second technical recession). 

However, the net effect is the same as forecast in May with zero growth during 2023. The economy is expected to perk up in 2024 and grow a modest 1.6%. 

Unemployment has been forecast to reach 5.3% in December next year, but that number has been progressively revised downwards since November 2022 when it was 5.7%.

The Monetary Policy Committee said, conditional on this economic outlook, that it expected the OCR would need to remain near its current level for slightly longer than assumed in the May MPS. 

However, ANZ’s Zollner said the Committee had signed off on a higher OCR track which suggests a bias towards lifting the rate. 

“At the end of the day, the data will determine what the Committee does, and they always reserve the right to change their minds,” she said.