BNZ economists look back at some of the reasons why the Reserve Bank made big OCR cuts in the past, finding such reasons don't currently exist

While there is currently plenty of "market chatter" over the possibility that the Reserve Bank (RBNZ) will make a super-sized 75 basis-point cut to the Official Cash Rate (OCR) next month, BNZ economists are reminding everybody that there is a "high hurdle" to the RBNZ making such big cuts.

After cutting the OCR from 5.5% to 5.25% in August, the RBNZ followed up with a 50 basis-point cut on October 9, taking the OCR to 4.75%. With annual inflation as measured by the Consumers Price Index (CPI) having come in at 2.2% as at the September quarter, and below the RBNZ's forecast of 2.3%, financial markets are aggressively pricing in potential future cuts.

Currently wholesale interest rate market rates are pricing in 100 bps of cuts across the next two OCR reviews - on November 27 and February 19 next year. The markets are pricing in 58 bps of cuts for the November review alone, which means effectively they are giving a nearly one-in-three chance that there will be a 75 bps cut on November 27.

In BNZ's latest Markets Outlook publication, BNZ senior economist Doug Steel has examined previous occasions when the RBNZ has cut by 75 bps or more, and he found the following three reasons:

1. When the banking sector was in turmoil. New Zealand’s most aggressive rate cuts occurred around the time that Lehman Brothers collapsed and led the world into the 2008/09 global financial crisis. The environment today is massively different. There are no major liquidity issues in the banking sector and bank balance sheets look sound.

2. A massive external shock. The initial response by the RBNZ to the Covid pandemic was to slash the cash rate 75 basis points. For now, there is no major shock impacting New Zealand. That’s not to rule out another large external shock at some stage in the future but there’s certainly nothing like it in the offing now.

3. A big CPI miss. The Q3 2022 CPI proved to be 0.8% higher than the RBNZ anticipated resulting in a sharp reaction from the Bank. The recent 0.1% miss (this time on the downside) is not exactly in the same category.

All the above does not rule out a 75bp move at the November meeting, Steel says.

"...But it is a strong reminder that, typically, the hurdle for the RBNZ doing so is high. We stick with our view of a 50 bp cut in November, as we continue to monitor all incoming information."

Westpac economists also expect that "with inflation looking well contained", the RBNZ will deliver another 50 bp cut in November, with further but more gradual cuts next year, and taking the OCR to 3.75% by May.

In Westpac's Weekly Commentary, senior economist Satish Ranchhod said last week’s inflation data will have made the RBNZ more comfortable with the "step up" in easing they delivered this month "as they should have greater confidence that inflation can be maintained close to 2%".

"We are not so sure they would have learned much on whether pricing behaviour has shifted given non-tradables inflation landed close to forecast [annual rate of 4.9% versus RBNZ forecast of 5.1%].

"In contrast, market pricing continues to fully price in 50bp cuts at both the November and February meetings, reflecting market concerns that inflation could slip significantly below 2% next year.

"We think that the shift in pricing for next year is looking a bit overdone," Ranchhod said.

He said it is "certainly possible" that inflation will slip below 2% [which is the level the RBNZ explicitly targets] for a period.

"However, any undershoot is likely to be modest and temporary.

"That’s in contrast to the 2010s when inflation persistently fell well short of 2% as a result of weak global demand following the Global Financial Crisis and the related weakness in the price of imported goods."

Ranchhod noted that at the moment,  imported prices pressures are soft, "and we’re keeping a watchful eye on conditions in China". But at this stage he doesn't expect "the same degree of weakness", especially with policy easing in many economies right now (including China).

In New Zealand there are signs that the downturn in the economic cycle is reaching a base, Ranchhod said.

While retail spending remains weak, the falls seen through the first half of the year have been arrested, with spending posting modest increases in the past two months. consumer and business confidence has been "tilting higher".

"Importantly, there are long lags with the transmission of policy changes in New Zealand with the vast majority of mortgages fixed for a period. By the end of this year, we expect the RBNZ will have delivered 125bp of easing in a relatively short period. Rather than pumping the gas, they will likely want time to observe how those reductions are propagating through the economy, especially as domestic inflation remains elevated.

"None of this detracts from the argument that monetary policy needs to be eased over the coming months – while inflation is looking benign, economic growth remains soft and the policy rate is still at a restrictive level.

"However, it’s likely the RBNZ will want to move more cautiously next year as interest rates head back to more normal levels."

Ranchhod said the RBNZ will also be mindful of the experience from the past few years when rapid rate cuts super-charged the housing market.

"We’re already seeing tentative signs that the housing market is thawing, with agents reporting increased interest from potential buyers and a modest 0.2% rise in prices in September – the first increase in five months."

The key area to watch will be the labour market, Ranchhod said.

"Unemployment has already picked up to 4.6% in the June quarter, and both we and the RBNZ expect it will have increased to 5.0% when the September quarter figures are released on 6 November.

"A sharper than expected deterioration in the labour market would be a concern for the central bank, especially if more timely indicators point to further weakening ahead."