Will concerns about a new banking crisis outweigh the need to bring down inflation? That’s the challenge facing the Reserve Bank of New Zealand, when it meets next week to decide whether or not to raise the Official Cash Rate (OCR).
A lot of movement is happening on a lot of economic fronts outside of New Zealand, so it’s hard to pick what direction Governor Adrian Orr and the rest of the RBNZ board will take.
In Australia, the annual rate of inflation has fallen below expectations, from 7.4% in January to 6.8% now, raising hopes that the country’s central bank will hit pause on interest rate rises.
The Reserve Bank of Australia raised the cash rate to 3.6% at the start of March, and investors, reeling from turmoil at Silicon Valley Bank in the US and Credit Suisse in Europe, are betting that Australia’s cash has now peaked.
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But the country’s big four banks aren’t with them, and predict the RBA will push up the cash rate by at least 0.25 percentage points on Tuesday.
Why the downbeat forecast? Well, the banking crisis hasn’t stopped rises elsewhere. Last week, the Bank of England pushed up UK interest rates by 0.25 percentage points to 4.25%, and the US Federal Reserve pushed up its rates by the same amount, bringing its benchmark rate to between 4.75% and 5%.
The cash rate in New Zealand hit a 14-year high of 4.75% in February after the RBNZ pushed up rates 0.5 percentage points. The post-hike sentiment was rates were close to peaking, and certainly much of the commentary in the immediate aftermath of the collapse of Silicon Valley Bank was that the banking crisis would stay the RBNZ’s hand and maybe even lead to rate cuts in the second half of the year.
Sentiment has changed, though. Annual inflation is at 7.2%, and while the next update of the Consumers Price Index (CPI) figures on April 20 may produce surprising results a la Australia, inflation remains public enemy number one.
In a speech delivered earlier this month, the RBNZ’s chief economist Paul Conway made it clear that he was committed to bringing inflation to the target rate of between 1% and 3%. “Quite simply, that’s our Job,” he said.
Conway noted that the cash rate was now “comfortably above neutral and having the desired contractionary effect”, adding that there were “welcome signs of demand in the economy slowing”.
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Economists at New Zealand’s big banks are unsure as to where the RBNZ will land on Wednesday, when it announces its cash rate decision (at the same time it will deliver its Monetary Policy Review, which among things will touch on the state of the housing market).
Kiwibank economists Jarrod Kerr and Mary Jo Vergara believe the RBNZ will cap rates at 5%, citing the Fed’s watering down of its aggressive rates policy and “shifting sands within the system”. "The RBNZ’s proposed hiking path to 5.5% is becoming increasingly unlikely. We have always said a move beyond 5% would be a step too far. And we believe the RBNZ will come around to this view," they wrote in their weekly note.
ASB chief economist Nick Tuffley also has an eye on what’s happening in the US. “The Fed’s message [on inflation and rates] has parallels to draw with our own RBNZ, which must take into account weather disaster impacts as well as potential fallout from the US banking challenges,” he wrote in ASB’s weekly economic update.
Tuffley believes that Conway's speech is a clear sign of the RBNZ's intentions. "The speech reinforced that the RBNZ is set to increase the OCR further, despite the surprise drop in Q4 GDP and the offshore wobbles."
ASB chief economist Nick Tuffley thinks the OCR will peak at 5.25%. Photo / Supplied
ASB's economics team expects the cash rate will hiked 0.25 percentage points in April and in May, "with the OCR on hold at 5.25% until Q2 2024, at which stage the OCR is trimmed to 3% by mid-2025".
ANZ’s economists are also predicting a rise of 0.25 percentage points next week, and will peak at 5.25% in May, “holding it at that contractionary level for the rest of our forecast horizon, which ends in December 2025”.
Westpac senior economist Michael Gordon does note that the clutch of bank failures overseas has put markets on edge. “If this were to blow up into a wider issue, past experience shows that New Zealand could find it harder and costlier to fund itself from overseas,” he says.
That could feed back into mortgage holders paying more if banks here find it more difficult to get overseas funding for those mortgages. “At this stage, though, there’s no sign of these sorts of pressures emerging,” says Gordon, “so the Reserve Bank’s interest rate decisions can stay focused on the fight against inflation.”
Gordon notes that the RBNZ’s response to inflation is now well advanced. “The OCR has been rising since October 2021, and has finally reached a level that the RBNZ considers to be contractionary.
“There are some early signs that this is having the desired effect, and that demand in the economy is starting to cool off. Even so, there is a lot of water to go under the bridge before we can be confident that inflation is coming back under control. Firms are still facing a range of cost increases, workers are still in short supply, and the upward pressure on wages remains strong.”
“We recently revised our OCR forecast to a peak of 5% this year, with one further 25-basis-point increase at the next review in April. However, with the RBNZ continuing to talk tough on inflation, the risks lean towards further cash rate increases beyond that date.”
Over at BNZ, chief economist Mike Jones thinks the housing market correction is nearing its end, but warns that the upturn on the other side may underwhelm.
Writing in BNZ's Property Pulse, Jones says house prices have another 4-5% to fall, "but our broader view is one where the correction is nearing its end and we may see signs of stabilisation emerge over coming months".
"Assuming we do see house prices level out around mid-year, attention will quickly shift to the shape of the recovery. Our view here is that it will be fairly underwhelming. Our assumption, and it’s no more than that, is for a 3% lift in prices over calendar 2024."
