BNZ economists say one of the tricky aspects facing the RBNZ is the 'market' desire to price in interest rate cuts next year

The Reserve Bank would not want to see mortgage rates falling any further at the moment, BNZ economists believe.

In recent days there has been a flurry of mortgage rate reductions as banks respond both to competitive pressures and the fact that wholesale interest rates have been easing.

These falls come after some very sharp increases in mortgage costs during the past year as our banks have responded both to the fact that the RBNZ has been hiking the Official Cash Rate to fight inflation and, more directly, due to some very strong earlier rises in wholesale interest rates - which reflected both the RBNZ's stance on inflation and what has been happening internationally in response to global inflationary pressures.

The RBNZ is set to make another decision on interest rates next week (August 17), and while there is virtually universal expectation that our central bank will hike the OCR by another 50 basis points (to 3.0%), there's a growing feeling in markets that the OCR could peak at around around 4% late this year and then maybe even be reduced again next year.

This is despite current annual inflation of 7.3% and a very clearly signalled intent by the RBNZ to get that inflation rate down and to curb 'inflation expectations'. The higher mortgage rates that have been seen in the past year are a big part of this, since higher mortgage payments curb spending and take steam out of what has been a very hot economy. A hot economy resulting in inflation.

In its most recent forecast of the likely track of the OCR (in the May Monetary Policy Statement) the RBNZ had (page 45) forecast the cash rate ending this year at around 3.5% before peaking at around 4% in June 2023. 

However, while the RBNZ had the OCR peaking in the middle of next year, it wasn't forecasting any falls until the second half of 2024. And this is where market opinion is now diverging somewhat, with some expectation of earlier falls than that.

In a preview of next week's OCR decision contained in the weekly BNZ Markets Outlook publication, BNZ head of research Stephen Toplis said one of the tricky aspects facing the RBNZ is the market’s "desire" to price in rate cuts next year.

"This is particularly pertinent given recent falls in home mortgage rates," he said.

Toplis said he didn't think the RBNZ would want mortgage rates falling any further "any time soon".

Next week's OCR decision will be accompanied by a new Monetary Policy Statement from the RBNZ that will include an updated forecast 'track' for the OCR.

"Sure, the cash rate [OCR] should fall back towards neutral in due course but it is unlikely the Bank [RBNZ] would want to indicate any material decline within twelve months of rates reaching a peak," he said.

He expects therefore that in the new cash rate forecast, the RBNZ will retain a "peak" to remain in place for around an 18-month period.

"In our opinion, the Bank [RBNZ] should be forceful in trying to dissuade those who are currently driving market pricing of such an easing.

"Realistically, however, pricing is as much about investors, particularly offshore, believing New Zealand’s yield curve must have a similar shape to the rest of the world irrespective of the local idiosyncrasies. It’s always hard for the central bank to stand in the way of offshore momentum."

The BNZ economists are forecasting a 50 point increase in the OCR next week followed by two lots of 25 points in the next two reviews to occur in October and November.

"We have been tempted to increase our October call to 50 but simply have not found any justification in the data to do so. And we are always conscious of not being data-whipped by the noise in the published figures. If, however, the RBNZ is adamant it will go 50 again in October then we will probably adjust our track accordingly."

Toplis said that from the market’s perspective the key things that are being mulled are:

• will the RBNZ give clear indication that it intends going 50 basis points in October?

• will it indicate an intention to deliver two more consecutive 50 point increases this year (October and November)?

• what will it print as its terminal (peak) rate?

"In brief we think:

• possibly;

• it shouldn’t, albeit that it won’t want to provide the market with any excuse to rally;

• same again, around 4.0%."

Toplis said he still thinks there is a risk the cash rate does not need to get to 4.0% to achieve the RBNZ’s required outcomes but see no reason why the RBNZ would want to change its most recent forecast of 3.95% given the evidence it has received to date.

"With two meetings, after the August one, before the end of the year, we doubt the RBNZ would want to rule out the possibility of a further 75 basis points of hikes during that period so it will likely signal this, leaving a further 25 points for next year."