Financial markets are "becoming attuned" to the risk that the Reserve Bank (RBNZ) may push the Official Cash Rate up by 75 basis points in its November review, ASB economists say.
In ASB's Economic Weekly, senior economist Mark Smith says the markets are now pricing in a 5% OCR by mid-2023 and therefore "there is likely more upside to NZ yields".
"The RBNZ looks like it means business and we are confident NZ inflation will eventually be brought under control.
"However, there will be casualties. Odds of an economic soft landing are also shrinking.
"We have also lowered our house price outlook, with inflation-adjusted cumulative falls sitting at a hefty 24%," Smith says.
Since beginning the latest 'tightening' interest rate cycle the RBNZ has hiked the OCR from the Covid-emergency-low of 0.25% as of October 2021 all the way up to 3.50%, and with more to come in November.
In its last forecast for the 'peak' of the OCR made in August, the RBNZ suggested a high-point of between 4.0% and 4.25% by the middle of next year. Since then, however, fears have grown globally of far more persistent inflation and this has helped to drive up wholesale interest rates - with ours rising accordingly.
Smith says that annual headline inflation rates in NZ and many OECD countries may "generally" be heading lower but are still around multi-decade highs and "a virulent economic and social problem that needs to be rectified".
"Once up, it will prove difficult to push inflation back down.
"Central banks are now living with the reality that to lower inflation to acceptable levels, it will take tougher talk and more restrictive policy settings than were initially envisaged."
In New Zealand, Smith says we seem to be past the peak in headline inflation, and there are some promising signs that headline inflation should head lower in future.
"Core inflation, however, will likely prove to be more difficult to dislodge from multi-decade highs.
"The RBNZ has the ‘inflation bit’ between its teeth. High core inflation, confirmation of a broadening front of price increases and that of a wage price spiral becoming more entrenched will likely necessitate a quicker and firmer application of the monetary policy brakes."
Smith noted that last week was another volatile one for local and global yields, with double-digit gains for most NZ swap and bond yields.
"Positioning and global influences look to have been the major drivers. Market pricing also firmed, with mid-2023 peak OCR expectations clearing 5% late last week. The 2-year swap yield peaked just shy of 5% (4.97%), its highest level since the GFC, with 10-year swap yields hitting 8-year highs (4.74%) but down at the end of last week. NZ Government bond yields were around 30bps higher with those for the 10-year tenor peaking at roughly 10-year highs (4.61%). Global yields have been volatile, but the trend has been upward..."
However, Smith say despite the "massive" increases of late, ASB economists have retained "our upward bias" for NZ yields.
"The RBNZ looks to remain steadfast in trying to push annual inflation below 3% and in its October Review left the door open to a possible 75bp November hike. Market pricing is adjusting to this possibility (61bps priced in for November), and risks are tilted to a more frontloaded pace of hikes."
ASB economists still expect a 50 basis point lift to the OCR in November (4% OCR), with a follow-up 25bp hike in February 2023 (4.25%).
"We then expect the RBNZ to hold for a period, with cuts from the second half of 2024 as the OCR is returned towards neutral levels (circa 2.5%-3%).
"Risks are heavily to the upside," Smith says.
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