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Economists warn there is a rising risk of deflation if the Reserve Bank doesn’t cut interest rates fast enough

Economy / news
Economists warn there is a rising risk of deflation if the Reserve Bank doesn’t cut interest rates fast enough

Economists are warning the Reserve Bank is running the risk of undershooting its 2% inflation target after seeing weak pricing data in the Quarterly Survey of Business Opinion (QSBO).

While business confidence has bloomed in ANZ’s monthly survey and the NZ Institute of Economic Research’s QSBO, it has done so from a low base and on the hope of rate cuts.

Actual data showed most firms had a difficult third quarter and many were expecting another tough three months ahead. A net 32% reported lower trading activity in September, and a net 2% expect the final quarter of 2025 to be even worse.

A net 41% of firms experienced cost increases, but only 3% were able to pass them on. This made them less profitable and pushed roughly a third of them to lay off staff.

ANZ’s business survey made headlines on Monday as confidence levels shot up to a 10-year high causing concern the Reserve Bank could be discouraged from further rate cuts.

But that survey asks about conditions one year ahead, while the QSBO focuses only on the current and previous quarters — both of which still look weak. 

Stephen Toplis, the head of market research at BNZ, said the results looked so weak that central bank policy makers were at risk of pushing inflation well below its target. 

His team had already forecast inflation being at 1.7% at the end of next year, and that risk has increased after a net 22% of merchants reported lowering selling prices in September. 

“Only twice in the history of this series, dating back to the 1960s, have weaker results been posted,” Toplis said. 

“A mere net 7% of respondents now intend to raise selling prices … we think a reading of this magnitude is consistent with annual CPI inflation falling [below] 1%.” 

Crash landing

The survey provided evidence the economy will recover, as interest rates fall, but it will be some time before the excess capacity gets used up and inflation pressure is generated. 

After years of missing its inflation mandate on the upside, policymakers at the Reserve Bank will desperately need to encourage growth to avoid failing again on the downside.

“While we are now touting a 50 point move we accept that this is a bold call and that a conservative central bank could easily baulk at an acceleration,” Toplis said. 

Most economists were predicting a 25 basis point reduction at the October meeting, which would bring the Official Cash Rate to 5%, but bond traders were leaning toward 50 points.

 Mark Smith, an economist at ASB, said he wouldn’t rule out a 50 basis point cut as the economy was still struggling and looser policy was “desperately needed”. 

The results of the QSBO would have had the Reserve Bank concerned inflation could drop below the 2% target soon and possibly settle there in the medium term, he said.

Others, such as ANZ’s Miles Workman, thought the dramatic rebound in confidence was a reminder that monetary policy works in both directions.

“Provided capacity indicators remain in disinflationary territory long enough to prevent disinflation progress from stalling at too high a level, the Reserve Bank should feel comfortable proceeding cautiously along the path laid out in the August Monetary Policy Statement”.

Both ANZ and NZIER thought the Reserve Bank would most likely deliver a 25 basis point cut at its meeting next week, having already got one in the bag from August.

Are we out of the woods yet? 

In addition to the two surveys, the Treasury also met with businesses and other organisations during September as part of its preparation for its next economic and fiscal update, scheduled for December.

It wrote in its fortnightly update that “the general feeling” among firms was that the economy was “at or near” the bottom of the economic cycle.

“Firms were expecting demand and activity over the remainder of 2024 to be soft but anticipated a pickup in 2025, as falling interest rates stimulate household spending and business investment,” analysts wrote. 

The retail and hospitality sectors were particularly pessimistic, with some firms reporting weaker activity than during the Global Financial Crisis. 

Residential construction companies had received an uptick in business enquiries since the Reserve Bank cut interest rates but it hadn’t yet translated into sales. 

“Firms thought further cuts were needed to provide developers and households with the confidence to ‘pull the trigger’ on new residential property.” 

Inflation pressures were generally easing but pockets of pricing pressure persisted. Some examples were shipping costs, insurance, electricity, and rates.

Treasury said one of the key takeaways was that businesses thought economic conditions were currently soft but expected to improve. 

Kiwibank economists agreed but warned the lift in business confidence was underpinned by the expectation of more rate cuts.

“The outlook has improved but the here-and-now demands more rate relief from the Reserve Bank, and quick, in order to stave off further unnecessary weakness in the Kiwi economy and labour market.”

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67 Comments

Economists are warning the Reserve Bank is running the risk of undershooting its 2% inflation target...

After the last few years of rapid price increases I think some commercial retrenchment is actually to be expected (and might even be welcomed by the public/government!) Many companies have been making hay while the sun was shining and realise they need to reposition to be more competitive as demand abates.

 

If we where transitioning from a stable economic environment at 2% I would be more concerned.

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Finally, some are starting to whisper about the big 'D'. In a debt-based economy, deflation is the main risk. It’s surprising how many still think inflation will just politely stop at 2% and not crash into the negative, especially after such an unprecedented hike and long hang at the peak interest rates.

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Next threat: fiscal surplus.

Could be in for a big shock.

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Fiscal stimulus from this lot? Unlikely.

Nah. The RBNZ created this mess. They must fix it. And perhaps they'll learn what humble means from it?

 

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What tools do RBNZ have to resuscitate the real economy?

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The real economy? Sadly, little to none. That's the realm of government. And a longer term realm that our governments are loath to step into. Need I mention our our screwed up tax system again? ;-)

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"unprecedented hike and long hang at the peak"

Don't you mean a return to normal interest rates. Too many limeys around here. We are not Europe and have never had their low interest rates. Look what happens to Kiwis when you give them cheap money.

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Yeah - massive asset (read: house) price inflation!

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Well, it's a risk for debtors who find it harder to pay, and for creditors who might not be paid. Either way, it tends to indicate against taking on or issuing debt that will be difficult to repay if conditions change even moderately. In the round I think that is a good thing.

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Deflation - already happening in China and Xi is using his financial Bazooka-whatever it takes - EU tried that didn't work out to well, but hey this is the Southern Hemisphere and its different down here - until it isn't and it wont be.

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Non-tradeable inflation (ie. domestic) is still 5.4%.  Its not likely to be 2% any time soon, let alone negative.

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If the RBNZ is both killing the economy and causing inflation to fall below zero then it's caused a Depression.

Let's use the right word.

Deflation isn't a real problem unless it becomes embedded (which it never has).

But a Depression is a major problem as it becomes self-feeding !!!

Just a reminder (once again) ... The RBNZ says the neutral rate for the OCR - where it is neither stimulatory, nor contractionary - is 2.75%. 

The OCR is now at 5.25%. That's contractionary by some 2.5% !!!

Thus the OCR would need to drop a whopping 2.5% to get neutral interest rates back into the economy.

Like I've said ... November 2023 was when they should have started cutting.

Pack of damn fools.

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Agreed - they must be aware of this though. 

How aggressive do they go now and where does the OCR sit by the end of the year? Sub 4%?

Next cut: 0.50%

Following cut: 0.75%

EOY: 4.00%

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"Agreed - they must be aware of this though? "

It's pretty clear they haven't a clue. Egos, doctrine and ideology is what the RBNZ is about. (Much like our government.)

Had they a clue? ... Well, like I said, November 2023.

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The OCR is still contractionary at 4.00%.

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Sounds pretty sound to me however RBNZ has yet to open it eyes to the real economy.

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The RBNZ seems to be fully in reaction mode, looking at the past not the future. 

Many of us picked this from the start because it is what always happens - arrive to the party too late then stay too long. You would think they would have learned by now...

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"The RBNZ seems to be fully in reaction mode,"

I'd agree.

Our current government said they would remove the Governor pre-election. They haven't. Another broken election promise?

Apparently our PM, Luxon, went to see Orr just after the election ....but left with his tail between his legs (which caused much mirth at the RBNZ).

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" The story of the 2% inflation target starts oddly in New Zealand. In 1989, New Zealand wanted to codify the independence of its central bank, and it directed the New Zealand finance minister and head of its central bank to come up with an inflation target. Why should the target not be 0%? After all, no one likes it when prices rise, so why not 1%? Why not negative inflation or deflation? Is there a reason for 2%? The figure was plucked out of the air... Once the central bank said that inflation would be 2%, everyone else assumed that it would be, too. "

https://sites.lsa.umich.edu/mje/2023/09/04/why-the-2-inflation-target/

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A basic understanding economics explains why you wouldn't want deflation - why would you invest/buy anything if you know it will be cheaper the next day?

Low levels of tamed inflation promote growth, erode debt. However, runaway inflation as we've seen causes cost of living pressures etc. as your income will never keep up. 

Obviously based on the above it is a balancing act but I don't think 2% was necessarily plucked from thin air..

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So you won't buy the latest TV when in all probability it will cost less in the future? (as has been the case for some time. Better TV's at a lower price keep coming)

A dynamic, efficient economy is supposed to be about more production, of a better quality at a lower price.

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People buy lots of things that get cheaper by the day. It would actually be a good thing if people only bought what they need, rather than what they think will go up in price. 

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Yep, it's what's happens with phone, tv and other tech items.  Want new shiny phone, but newer shinier phone is only a month away, and current phone isn't actually dead yet... So wait.

 

The real problem with a deflationary system is in the cost of labour.. or rather the opposite side of that equation.   If Bob earns $60/hr now, how are you going to make him accept $55/hr for the same job next year?

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Exactly, and if bob thinks he’s going to earn ~10% less next year, what percentage of his wage will he not spend this year to make sure he has enough next year? And if everybody is desperately trying to save, nobody is spending, production winds down and our standard of living dramatically unwinds.

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That's only half the expectation though; if he expects 10% less income, it's also because he'd expect prices to be down by the same amount. He wouldn't need to save now for retrenchment next year, since the price level would have dropped commensurably.

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Richard makes $28 an hour, we need his wages to drop to $25 an hour.  Who tells his landlord the rent must drop $120 per week? 

What if his landlord is already topping up the mortgage because the rent doesn't cover all outgoings?  What if his landlord is Bob?  

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That's depreciation, not deflation. 

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Dammit, Bob's our best worker, we can't cut his pay! Come to think of it we can't cut anyone's pay!

Tell the workers to line up out front

...

Right, everyone who works here take one step forward.

Not so fast, Dave...

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Like Jfoe suggests - and I vehemently support - tax the things we don't need. Wiser economies than ours do exactly this.

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Here;s my list for starters - Lawyers/Economists especially Bank ones/Bureacrats/

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I don't think it was plucked out of the air. High inflation is bad, deflation is bad, 2% is probably furthest from both. 

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Deflation isn't bad.

We've been brainwashed into thinking it is. It should be part of a healthy economic cycle. A cycle that allows malinvestment, waste and poor quality to be eradicated from the otherwise 'good stuff'.

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"Deflation isn't bad."

Really? Tell me how.

Coupled with a Recession we call that a Depression.

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We could be like Japan - go to all the effort to produce lots of stuff yet have a lower GDP per capita than we currently do. 

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If we become more efficient producers overall, say due to a technological revolution, then we would expect deflation. That is, producing more, selling it for less, but maintaining living standards. Frankly that is exactly what we should be aiming for.

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Why should the target not be 0%? Low inflation targets would surely incentivise money hoarding. After all, money moving through the economy and people remaining employed when they’re able to work, both positives. Ultimately this keeps us spending, investing etc because our dollar is worth less if we don’t. IMO this is an apt argument as to why Bitcoin could never be a useful currency. There’s no incentive for trade, only incentive to hodl.

Now as to what we try funnel all of that spending towards, that’s more of an issue than the 2% inflation argument.

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Let's stop beating around the bush, it's clear that gradual lowering of interest rates has been our primary economic driver for the last 30 years, but we hit a road block when the OCR stopped at 0.25%.  We need interest rates to continue to fall ad infinitum.  

It's time we introduced negative interest rates.  Rather than having people take out big loans to profit from denying others ownership of shelter, just let them make a profit off the loan itself....Have the banks charge depositors for the service of storing their money.  

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LOL. At least, I'm assuming you're jesting?

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Most of my comments are in jest or sarcastic satire.  

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That was the original role of a bank -  a storage firm for your gold.

Worked ok until some fool decided rehypothecation was a good idea - the forerunner to fractional reserve banking.

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Have we ever had deflation in New Zealand? Prices only ever go up, right?

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Absolutely, deflation has happened in New Zealand before
https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/inflation

 

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But not for 95 years.

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While true, our banking system, particularly the role of the RBNZ and the fire power it has been given, mean that the 1930s are unlikely to be repeated anytime soon although climate change could throw a huge spanner into that assertion. (That said, our RBNZ appears to be hell bent on making a mess of just everything at this time.)

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Tip of the cap to those who called for rate cuts at least 6 months ago

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We thank you.

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Reverse some of the recent inflation?

Good.

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Import prices up 25% since 2020. CPI also up 25% since 2020. Our prices have adjusted to a global shift in the price level. Is that inflation? 

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Yes. Our prices have adjusted to a local increase in the money supply.

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An increasingly fringe view. For good reason.

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Oh good grief...

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It is undeniable that rapid increases in the OCR drove up business costs which then needed to be passed on as prices increases.

So yes.

How much, though, will be enlightening. Hopefully enough to force a rethink of the OCR as primary tool to control inflation.

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RBNZ have crashed the economy by reducing housing disposable income and adding $10bn to business costs (putting upwards pressure on the prices they are trying to slowdown).

Now RBNZ are reducing interest rates. Every 100pts they drop will lower business costs by around $2bn per year (about 1% of total private consumption). On top of this, the price of oil, the most impactful input price in our economy, has fallen sharply. These cost reductions will enable businesses to lower prices if they want or need to.

If RBNZ panic about deflation, what will they do? They will drop interest rates even faster - reducing business costs more quickly, and enabling businesses to charge even lower prices to attract a diminishing number of people who still have money to spend! Brilliant!

But, wait! There's a spanner in the works. RBNZ can't reduce interest rates more quickly than the Fed or they risk tanking the currency. So, what will they do? Will they reflect on their awful handling of the last four years and hand in their notice? Nope, they will say to Govt 'We have heroically tamed inflation - done a great job in fact, but, sorry, we don't have the tools for a regeneration job, you might need to spend some money'.  

  

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NZD has been gaining against the USD over the last 2 months so RBNZ has some room to drop faster than the FED.

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"There's a spanner in the works. RBNZ can't reduce interest rates more quickly than the Fed or they risk tanking the currency."

Might be good thing. (And I disagree that the RBNZ can't. They can! And at this time it would likely be a good thing.)

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Sorry, should have said 'won't'.

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Don't worry, Orr will respond far too heavily, far too late. As is tradition.

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"Economic history suggests that periods of mild deflation do not inevitably have adverse effects....Benign deflation may be an effect of improved potential in the supply side of the economy. This can be manifested in stronger growth in productivity, due to technological advances, increases in labour productivity, lower per unit costs of production or successful structural policies.
Unlike the case of a collapse in aggregate demand, positive supply-side developments generate stable spending in the economy, since the fall in prices is compensated for by an increase in the level of output. The downward pressure on prices results in increased real incomes for those whose income remains unchanged or rises..."

https://www.europarl.europa.eu/RegData/etudes/BRIE/2015/559492/EPRS_BRI…

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From a debt freak like yourself, BW, that's a great post.

But the fact remains - the 'economists' quoted are using the wrong word. They should be using the word 'depression'.

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"Historically, deflation occurred quite frequently in the late 19th and early 20th century
and then again between the two World Wars. There have been fewer episodes of
deflation since. A recent paper by the Bank of International Settlements (BIS) examined
deflation in 38 countries over the past 140 years. The authors concluded that, even
though deflation and economic depression may coexist in the same period of time, there have also been many episodes during which deflation was not strongly correlated
to weak economic growth (or even had a positive influence). They point out that, rather
than a general fall in price levels; it is the fall in property and equity prices (such as stock
market crashes or housing bubbles bursting), which influence economic growth in the
most negative way. Other economic research found insignificant links between
deflation and depression (except during the Great Depression);3 broad reviews of
economic papers confirm the same findings"

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Deflation would equal negative leverage. Stock up on pepto pills.

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Where is this additional spending power to come from?....are banks willing to forego risk to lend to all and sundry?....are the coalition suddenly going to turn profligate?....will the 30% of households gradually rercieving mortgage relief ignore all their other cost increases and suddenly start spending like there is no tomorrow?

Hopium, writ large.

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We get an extra $100 a week to spend for every 1% cut. Will we spend all of it - probably not. But I’m sure we’ll spend some. 

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Mortgage holders (on average) get an extra $100 pw  per 100 basis point drop...eventually....but they also have increased(and increasing) rates, insurance, grocery, service costs....not to mention a less certain employment environment....how much do you think will find its way into discretionary spending, anytime soon?

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On that basis, probably none. I have heard of people that I thought were quite well off having to sell stuff to keep going. If they gain some cash back through lower interest rates or whatever all that will happen is that they will not need to sell stuff to stay afloat. But asset prices (particularly housing) will still be in decline.

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Deflation is often misunderstood. It's not just about price drops, which might sound good initially. Debt-defaults = deflation. It’s deeper than just saving a few bucks.

We are likely to see a lot of forced changes in ownership ahead.

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Something like this....?

"If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their Fathers conquered

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