Westpac economists are now picking the Reserve Bank (RBNZ) will need to raise the Official Cash Rate (OCR) to as high as 6% - which is a new high forecast among major bank economists.
At the moment the OCR is at 5.25% and most economists have been forecasting there will be one more hike of 25 points at the next review next week, making the peak 5.50%.
However, in Westpac NZ's latest economic overview, Westpac NZ chief economist Kelly Eckhold says getting inflation back to sustainable levels [it's currently 6.7%] won’t be easy and that more is required to achieve this goal within a reasonable timeframe.
"As a result, we’ve revised up our forecast for the peak in the Official Cash Rate to 6%. Inflation has already been outside the target range almost two years, and our projections indicate it’s going to take another 18 months to get inflation back within the [1% to 3% target] band.
"The economy likely won’t slow as much as we feared a few months back. Net migration has rebounded faster than expected and population growth is set to rise to its highest level in decades.
“As a result, it’s less likely now that we’ll see the economy tip into outright recession, and the house price cycle looks to have bottomed out sooner than expected."
The Westpac economists say that since mortgage rates began rising in 2021, house prices have fallen by an average of 17% across the nation.
"However, rising population growth along with lower longer-term mortgage rates are likely to provide a brake on those declines. We’ve revised up our forecasts for house price growth, and now expect that mid- 2023 will be the bottom for the housing market. As interest rates are set to remain at contractionary levels for some time, we think the extent of the upswing should be limited – although this crucially also depends on the future path of migration."
The economists forecast house price falls of 3% for this calendar year and then an increase in house prices of 2.5% in 2024.
The Westpac economists are forecasting now a net inflow of 100,000 people over 2023, adding almost 2% to New Zealand’s population.
"This would be a stronger growth impulse than we’ve seen at the peaks of previous migration cycles," they say.
"...That sharp rise in net migration will see population growth rising from just 0.5% at the end of 2022 to 2.4% by the close of this year. That would be the fastest rate of population growth New Zealand has seen in decades, and it signals a large increase in many businesses’ demand base."
They concede there's a great deal of uncertainty about what may happen and that the current inflow might peter out.
They say there’s also a great deal of uncertainty around how this rebound in migration will flow through to the wider economy.
"On one hand, an influx of workers may help to take the upward pressure out of wages – employers are certainly hoping this will be the case.
"But in other areas they are likely to add to already- strong demand, particularly in housing, where population growth is set to outstrip the pace of homebuilding in the year ahead. This uncertain balance will also have important implications for monetary policy."
Unfortunately, the surge in migration "has the potential to disturb the grand plan" the Reserve Bank has for reining in inflation, the economists say.
"The Reserve Bank has long regarded migration as an inflationary force on balance, adding more to demand than supply in the near term.
"Regardless of whether that proves to be the case this time, the RBNZ has little room to tolerate any upside surprises to the inflation outlook, and a continued surge in migrant inflows is likely to be met by policy action rather than waiting to observe its impact on inflation. For this reason, we now expect the Official Cash Rate to peak at 6% this year."
The economists say that this migration cycle is hard to assess in terms of its amplitude and duration.
"But based on what we can see now, it seems clear that New Zealand will see strong population growth that will add significantly to both the demand and supply for resources. The world is moving again post-Covid and countries like New Zealand are seeing people seek out opportunity and lifestyle benefits that have not been available for much of the last few years."
So, the economists argue that the monetary policy tightening cycle is not yet over, "and that more insurance is required" to be sure of bringing inflation back into the target range.
"We see the OCR rising further to 6% by August and remaining there until mid- 2024 when it should be clearer that inflation pressures have substantially moderated. By then CPI inflation should hopefully be closer to 4% and falling. For the Reserve Bank, the prospect of reaching the promised land of 3% inflation will be more than just a figment of an economic forecaster’s wild imagination."
The economists say that as always, significant risks to this central outlook exist.
"But our sense is that these remain to the upside in terms of inflation persistence and hence interest rates. A key upside risk is the size and amplitude of the migration cycle we are now firmly within. We have included a reasonable assessment of what might be expected but if a greater and more protracted migration cycle eventuates then we would expect the net demand impact on the economy and inflation to be greater and more persistent. If inward migration triggers an early return to a strong housing market, then the resultant boost to consumption, investment and the labour market could really challenge the assumption that inflation expectations remain anchored to the 1-3% target range.
"Downside risk scenarios can be contemplated – particularly with respect to the degree to which the tightening which has already occurred impacts domestic spending now we are firmly in the “sweet spot” of their impacts on the economy and inflation. But our sense is that the RBNZ would gratefully accept such surprises as gifts which would speed the return of inflation to target as opposed to raise significant concerns that tightenings are overdone, and policy reversals are necessary.
"Better to finish the job now than to have to come back with stronger more painful measures later."
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