When doves fly: Reserve Bank sees potential for two further OCR cuts by early next year and warns cautious behaviour by households and businesses could further dampen economic growth; Hawkesby has applied for RBNZ Governor job

The Reserve Bank (RBNZ) has cut the Official Cash Rate (OCR) to 3.00%, from 3.25% and indicated a much more 'dovish view' of future developments, with two members of the RBNZ's six member Monetary Policy Committee (MPC) actually voting for a 50-point OCR cut.

An OCR low point of 2.5% is now seen as a real possibility by the RBNZ. 

At the media conference later on Wednesday, RBNZ Governor Christian Hawkesby effectively conceded the OCR would likely be 2.5% by the end of the year, while not being drawn on specific decisions.

"Every decision of the Monetary Policy Committee [MPC] is always live. No decisions have been made for future dates at this point," he said.

"It’s true we have revised down significantly our Official Cash Rate projection in the [Monetary Policy Statement] document. That’s largely around the news about the starting point for the economy, for New Zealand. So that stalling of growth we’ve observed through Q2. That’s meant that there’s more spare capacity for longer than previously and that’s meant we can have interest rates lower to support the economy and get the right amount of domestic inflation pressure.

"That projection troughs at around 2.5% by the end of this year and so that would be consistent with further cuts through the course of this year. Whether we end up going faster or slower than that will be determined by developments over that period," he said.

Split vote

There were differing views among the six members of the MPC deciding on the OCR. This resulted in only the third vote in the history of the MPC - and the most split vote so far, with four voting for the 25 point cut and as stated above, two voting against and in favour of a 50 point cut.

As evidence of the divergence of opinions, the MPC discussed three policy options: keeping the OCR on hold at 3.25%; cutting the OCR by 25 basis points to 3%; or cutting by 50 basis points to 2.75%. 

This highlights the emerging contrast between a flagging economy and rising inflation. Remember, the RBNZ is charged with maintaining inflation between 1% and 3% and it specifically targets 2%.

The RBNZ's new forecasts contained in the August Monetary Policy Statement (MPS) show it's forecasting the OCR may now go as low as 2.5% by early next year. The previous projection in the May MPS saw a low point for the OCR of maybe 2.75% by March - though it was hedging its bets between 2.75% and 3.00%.

A further cut at the next OCR review on October 8 will now be regarded as forgone conclusion.

Market reaction was quick. The Kiwi dollar dropped over half a cent against the US currency to US58.3c, while wholesale interest rates quickly tumbled, with the two-year swap rate, for example, falling over 10 basis points to under 3.00%.

'Very dovish'

BNZ head of research Stephen Toplis said in light of Wednesday’s "very dovish" RBNZ statement, the BNZ economists are now forecasting the OCR to go to 2.5%.

"In addition to the 25 point cut to 3.0% today, we maintain our view that a further 25 point reduction will be delivered in October. We now add to that an expectation a final 25 point cut at the November statement taking the low in the cash rate track to 2.5%. Our previous expectation was for a low of 2.75% with downside risk," Toplis said. 

In its latest statement the RBNZ says on the one hand that it expects annual inflation (2.7% as of the June quarter) to hit 3% by the end of the current (September) quarter, but also expects that the economy contracted again in the June quarter (the results of which won't be known till September). The RBNZ does expect inflation to fall quickly and return to around the 2% target mid-point by mid-2026.

Hawkesby said further data on the speed of New Zealand’s economic recovery will influence the future path of the OCR.

"If medium-term inflation pressures continue to ease as expected, there is scope to lower the OCR further."  

Between 2021 and mid-2023 the RBNZ hiked the OCR all the way from the pandemic emergency setting of 0.25% to 5.5% as the central bank battled to control runaway inflation that hit 7.3% in mid-2022. With inflation returning into the targeted 1% to 3% range, the RBNZ started cutting the OCR in August of last year, and now some 250 points have been cut.

The backdrop to this latest OCR decision is that inflation has started to spike again (annual rate 2.7% as of the June quarter) while the economy, after a 0.8% rise in GDP in the March quarter, is struggling and is largely thought to have stalled again in the June quarter. Although now the very latest high frequency economic data is suggesting there may signs of a renewed, tentative, pickup.

The mixed economic picture has prompted an unusual level of divergence among economists and commentators, with some saying an OCR level of around 3% is sufficient, while other argue the cash rate must be dropped to 2.5% or even lower - in order to get spending going and the economy firing again.

Up for the Job

Separately, Hawkesby was asked about the Governor's job. Hawkesby was made acting Governor on March 5 after the abrupt resignation of Adrian Orr ,and was then officially appointed for six months while the recruitment of a Governor to serve for a five-year term takes place. Hawkesby’s appointment may be extended by the Minister of Finance for up to three additional months.

Hawkesby would not be drawn in detail, but did concede he had applied for the job.

"I did manage to find time to dust off my CV and throw it in and we’ll leave it at that," he said. 

This is the statement from the Reserve Bank:

Annual consumers price index inflation is currently around the top of the Monetary Policy Committee’s 1 to 3 percent target band. However, with spare capacity in the economy and declining domestic inflation pressure, headline inflation is expected to return to around the 2 percent target midpoint by mid-2026. 

New Zealand’s economic recovery stalled in the second quarter of this year. Spending by households and businesses has been constrained by global economic policy uncertainty, falling employment, higher prices for some essentials, and declining house prices. 

There are upside and downside risks to the economic outlook. Cautious behaviour by households and businesses could further dampen economic growth. Alternatively, the economic recovery could accelerate as the full effects of interest rate reductions flow through the economy. 

The Monetary Policy Committee today voted to decrease the Official Cash Rate (OCR) by 25 basis points to 3 percent. Further data on the speed of New Zealand’s economic recovery will influence the future path of the OCR. If medium-term inflation pressures continue to ease as expected, there is scope to lower the OCR further. 

Summary of Monetary Policy Committee meeting:

Annual consumers price index inflation remains within the Monetary Policy Committee’s 1 to 3 percent target band. Recent increases in food prices and administered prices have contributed to near-term inflationary pressure. However, domestic activity has been subdued and there remains significant spare productive capacity in the economy. Headline inflation is expected to return to around the 2 percent target mid-point by mid-2026. If medium-term inflation pressures continue to ease as expected, there is scope to lower the OCR further.

Annual CPI inflation remains within the target band 

Annual consumers price index (CPI) inflation increased to 2.7 percent in the June 2025 quarter. Headline inflation is expected to reach to 3.0 percent in the September 2025 quarter, reflecting large increases in administered prices, food prices, and the prices of other tradable goods and services.

Surveyed measures of medium-term inflation expectations remain near 2 percent, consistent with the mid-point of the target band. Non-tradables inflation has continued to decline in aggregate. Measures of core inflation have declined and are within the target band. Headline inflation is expected to converge to the mid-point of the target range over the next year as tradables inflation pressures dissipate and significant spare capacity continues to reduce domestic price pressures. 

Near-term inflation expectations have increased, particularly for households. Household inflation expectations have risen across several advanced economies and may be influenced by global factors such as increased trade restrictions, as well as relatively large increases in some prices such as those for food and energy. 

Tariffs and economic policy uncertainty are dampening the global economic outlook

Evidence to date suggests that the global economy is responding broadly as expected to trade restrictions and policy uncertainty. Growth in some of our trading partners, particularly China, was higher than expected in the second quarter of 2025 but is expected to moderate in the coming quarters. Headline inflation has increased moderately in some advanced economies but is declining in most of our Asian trading partners.

Tariffs are causing changes to global trading patterns but have so far had a limited effect on aggregate global trade volumes. To date, there is no evidence of major disruption to global supply chains, or a material impact on the prices of New Zealand’s imports or exports. The Committee noted that it continues to expect that the increase in global trade restrictions will result in less inflationary pressure in the New Zealand economy.

The effective tariff rate on New Zealand exports to the United States is higher than anticipated at the time of the May Statement. Some firms and industries may experience more challenging export conditions as a result. The medium-term implications for New Zealand will depend on how global demand responds to increased trade restrictions and economic policy uncertainty.  

Economic growth in New Zealand is expected to recover gradually

High-frequency indicators suggest that the New Zealand economy contracted in the second quarter of 2025 and was weaker than expected at the time of the May Statement. Growth is expected to resume in the September quarter, consistent with a recovery in some economic indicators for July. A key judgement for the Committee’s economic assessment was the extent to which spare capacity in the New Zealand economy is likely to persist. 

The Committee discussed constraints on household wealth and discretionary income. Employment and hours worked have declined, and wage inflation has slowed sharply over the last year. Household dissaving since the start of 2022 has reduced savings buffers. At the same time, inflation in some essential expenditure components such as food, gas, electricity, and council rates has been much higher than the general rate of inflation. These factors were noted as likely to contribute to a slower recovery in domestic spending than would otherwise be the case. 

House prices have declined to a level within the Reserve Bank’s range of sustainable house price estimates. Housing is a key component of household wealth, which influences household spending. Ongoing weakness in the housing market is contributing to subdued residential construction and household consumption. 

The Committee discussed the fiscal outlook. Declining government spending as a share of the economy is expected to reduce inflationary pressure in the medium term. This is consistent with the economic and fiscal projections published in the Budget Economic and Fiscal Update 2025.

The Committee acknowledged regional and sectoral divergences in economic activity. House price growth has varied considerably across regions. High commodity export prices are supporting activity in the agricultural sector, resulting in stronger spending in rural areas. However, to date, many agricultural businesses have used higher export revenues to pay down debt, limiting the pass-through to consumption and investment.   

There is significant spare capacity in the New Zealand economy

A broad range of indicators suggest that significant spare capacity in the New Zealand economy persists. Unemployment has increased, as have measures of labour underutilisation, and firms are reporting that it is relatively easy to find labour. Firms are also reporting low levels of capacity utilisation. The Committee noted that while credit is generally available, growth in business lending has been slow. 

The Committee discussed slow growth in the productive capacity of New Zealand’s economy. Potential output growth has slowed, reflecting subdued investment, low productivity growth, and historically low population growth through net immigration. The Committee noted that appropriate monetary policy settings would support sustainable long-run investment and growth. 

Monetary policy continues to transmit through the financial system

The Committee noted that wholesale interest rates have fallen since the May Statement, resulting in lower mortgage and term deposit rates, particularly at shorter terms. The average interest rate on the stock of mortgages is expected to continue to decline over the coming year, as about half of existing mortgages are expected to re-fix onto lower rates over the next six months. This will reduce debt servicing costs for households as past reductions in the OCR continue to transmit through the financial system. 

Long-term bond yields have increased internationally over the first half of the year, with higher term premia reflecting geoeconomic uncertainty and elevated debt levels. Despite subdued domestic activity, the New Zealand dollar TWI has been relatively stable through this period, in part due to policy developments and declining short-term interest rate expectations in the United States. Equity prices in the United States have been elevated, but this has largely been attributable to the out-performance of a few large technology firms. 

The financial system remains stable

The Committee was briefed on financial system stability. Subdued demand and low profitability are contributing to financial stress for some businesses. Non-performing loans for households and businesses have increased but remain low relative to previous cycle peaks. Increased provisions and strong capital buffers mean that banks are well-prepared to absorb any losses. The Committee noted that monetary policy settings that support growth in the economy will also contribute to financial stability.

There are upside and downside risks to the economic outlook

The Committee expects headline inflation to remain within the target band over the forecast horizon. However, with inflation projected to increase to 3.0 percent in the September quarter, there is a material possibility that it rises above the target band. The period in which this is most likely to occur is too soon for monetary policy to have any meaningful effect. However, if inflation were to remain higher for longer than expected, there is a risk that this influences inflation expectations and wage- and price-setting behaviour over the medium term.

The Committee noted that increases in administered prices, such as local council rates and some energy charges, have contributed to higher-than-otherwise non-tradables inflation. Some members emphasised that these prices represent rising costs for businesses and may spill over to generalised non-tradables inflation, particularly in the near term. Other members emphasised spare capacity and weak demand, which would limit the ability of firms to pass on cost pressures to consumers. 

Some members also drew attention to slow growth in parts of the economy that are most sensitive to interest rates. Residential construction, house prices, and retail activity have not materially recovered, despite monetary easing to date. On a quarterly basis, non-tradables inflation excluding central and local government charges is consistent with inflation at or below the target mid-point. Some members suggested that this may represent a downside risk to medium-term inflation. Other members emphasised that previous reductions in the OCR continue to transmit through the financial system and will take time to have their full effect on activity and inflation. Growth in interest-rate-sensitive sectors of the economy is projected to recover over the remainder of this year. 

The Committee discussed the extent to which uncertainty associated with global trade restrictions is likely to limit domestic demand and inflationary pressure in the medium term. Consumption and investment demand appear to have weakened in the second quarter of 2025, partly in response to heightened trade policy uncertainty. The effects of uncertainty on domestic activity are assumed to persist over the remainder of the year. Some members emphasised the fact that some measures of uncertainty have improved considerably since May and noted a possibility that the domestic economy recovers more rapidly as the effects of uncertainty dissipate. Other members highlighted that excess supply in China and some parts of emerging Asia has the potential to lower tradable inflation in New Zealand over the medium term.  

Some members also emphasised the risk that precautionary behaviour by New Zealand households and businesses may result in a weaker consumption and investment outlook than assumed, particularly in the context of slow growth in household wealth and discretionary incomes and low firm profitability. In this environment, businesses that are uncertain about potential future demand are less willing to invest, which in turn lowers potential growth and could further prolong uncertainty about future incomes and wealth. It is possible that pessimistic sentiment, together with the initial negative effects of the global tariff shock, have dampened the effects of the reduction in the OCR since last August. 

The Committee noted limits to the ability of monetary policy to influence expectations of long-term growth. Some members emphasised that near-term support from monetary policy is most effective when combined with regulatory and policy settings that promote innovation and investment to support productivity growth.  

The Committee voted to reduce the OCR to 3 percent

The projected path of the OCR reflects the Committee’s central expectation of the path needed to ensure that inflation settles sustainably near the target mid-point. Uncertainty about the future path of the OCR is reflected in the Committee’s discussion of upside and downside risks to the outlook. Some members considered the balance of risk to be to the upside relative to the projected path, while others considered the balance of risk to be to the downside.

The Committee discussed three policy options: keeping the OCR on hold at 3.25 percent; cutting the OCR by 25 basis points to 3 percent; or cutting by 50 basis points to 2.75 percent. 

The case for holding the OCR steady at 3.25 percent focused on positive influences on growth. Global economic activity outside of the United States has so far proven resilient in the face of new trade barriers, and global policy uncertainty has reduced from its peaks in April and May. The full extent of recent monetary easing is yet to fully transmit through the economy. Although high-frequency indicators suggest weak economic activity in the June 2025 quarter, available indicators for July suggest some improvement. With inflation approaching the top of the target band, and near-term inflation expectations rising, it could be prudent to pause to observe incoming data. One member gave relatively more weight to this view.

The case for lowering the OCR by 50 basis points to 2.75 percent emphasised declining inflationary pressure and significant spare capacity. Some members put relatively more weight on the risk that the negative consequences of global policy uncertainty on domestic consumption and investment are self-reinforcing and therefore more persistent. A larger reduction in the OCR might disrupt such a dynamic and generate clearer signals that support consumption and investment, whereas a gradual reduction in the OCR might not provide the same positive signalling effect. These members also emphasised that weakness in the labour market and excess capacity limits the upside risk to inflation should the economy recover more quickly than projected.

The case for lowering the OCR by 25 basis points to 3 percent was based on the upside and downside risks around the central projection being broadly balanced. Financial conditions are continuing to respond to past reductions in the OCR. They are also influenced by expectations of the future path of the OCR, which provides sufficient signalling effects. If medium-term inflation pressures continue to ease in line with the Committee’s central projection, the Committee expects to lower the OCR further. Reducing the OCR by 25 basis points at this meeting provides the opportunity to adjust this view incrementally in response to new information. 

On Wednesday 20 August, the Committee voted on the options of either reducing the OCR by 25 basis points or reducing the OCR by 50 basis points. By a majority of 4 votes to 2, the Committee agreed to decrease the OCR by 25 basis points to 3 percent.   

The August Monetary Policy Statement is here.