The Reserve Bank plans to keep cutting rates but doesn’t want to risk inflation reigniting

Policymakers at the Reserve Bank considered cutting the Official Cash Rate on Wednesday but chose to hold fire until August when they will have more solid economic data. 

By then, they’ll have a clearer view of whether the recovery has stalled and if headline inflation pressures are becoming entrenched. The June Consumers Price Index is due later this month, along with a fresh set of high-frequency activity indicators.

The latest figures point to trouble on both fronts. Economic momentum appears to have stalled after a strong start to the year, while food prices are pushing inflation above target.

Activity indices for the services and manufacturing sectors took a "disastrous" dive in May. BNZ economists said the data were consistent with a return to recession, though they were not forecasting one.

Retail spending dipped 0.2% in May and has been falling on a per capita basis since late 2022. A rally in late 2024 was short-lived, as was the lift in real disposable income.

Unemployment likely edged higher during the quarter, and the expected rebound in house prices has yet to materialise. GDP also looks to have declined in June, according to Nowcasts.

Yet business confidence remains strong. A net 18% of firms expect their own activity to improve next quarter, even as they report another slowdown in June.

The RBNZ must decide whether this is just one bad quarter—a bump in the road—or a more serious stumble that needs monetary support to correct.

And while central bankers weigh up these signals, headline inflation keeps climbing toward the top of the target range as food, energy, transport, and tax prices rise.

Faltering recovery

In its July record of meeting, the Monetary Policy Committee said near-term growth momentum was weak and warned that “excess caution” by households and businesses could lead to “prolonged weakness”.

“Some members emphasised that further monetary easing in July would provide a guardrail to ensure the recovery of economic activity, whilst being consistent with price stability,” the record said. 

However, with a high level of uncertainty clouding the outlook, others argued it was better to wait until August for a clearer view of “near-term inflation risks”.

“Some members emphasised that waiting would allow the Committee to assess whether weakness in the domestic economy persists, and how inflation and inflation expectations evolve”. 

The Committee was clear it expects to cut the Official Cash Rate from 3.25% to 3.00% in August—provided nothing unexpected shows up in the June data.

Call for cuts

Sharon Zollner, chief economist at ANZ, said Wednesday’s pause had been well signalled, but there was clearly still a robust debate around the committee table.

ANZ expects inflation concerns will fade as the economy recovers more slowly than forecast, clearing a path for the OCR to fall to 2.5%.

Stephen Toplis, head of research at BNZ, said there were few signs the economy had enough momentum to close the wide output gap without more stimulus.

Economists at Kiwibank said the record of meeting emphasised there was “significant spare capacity” and a “large negative output gap” in the economy. That language, they said, was itself significant and perhaps hinted at a willingness to continue cuts beyond August.

The Reserve Bank was aware of the temporary inflation spike as food, energy and local tax costs rose—but should be more focused on the weakening economy.

“But a spike is still just a spike. In the medium-term, the RBNZ continues to expect headline inflation returning to around 2% by early 2026. So, if it had been us today, we would have cut”.

Brad Olsen, chief executive and principal economist at Infometrics, said he wasn’t convinced the Reserve Bank should take the OCR below 3%, as financial markets are predicting.

“Although some pricing pressures are expected to fall back, we remain worried enough about inflation sticking around too high for too long,” he said. 

Another notable shift was in the RBNZ’s view of the global trade war, which no longer appears likely to drive inflation in New Zealand.

“The Reserve Bank is most uncertain, and therefore cautious, about how persistent near-term inflation pressures might be, and about the speed and breadth of the domestic economic recovery. In our view and reading of the July Review, global trade uncertainty appears to be less important,” Olsen said.