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By Tony Alexander
The Reserve Bank does not share the pessimistic outlook for inflation.
ANALYSIS: Over the past few weeks, after the Reserve Bank surprised financial markets by increasing the official cash rate (OCR) by 0.5 percentage points on April 5 rather than 0.25, some analysts have been competing against each other to lift their predictions of where the official cash rate will go. The top pick has been that the cash rate will go to 6% and on that basis one could reasonably expect up to another 0.5 percentage increase in one-year fixed mortgage rates and maybe 0.2 or so for the two-year rate.
But what we have just learned is that the Reserve Bank does not share their new pessimistic outlook for inflation which seems to have been turbocharged recently by the much higher than expected net immigration numbers.
The Reserve Bank increased OCR by 0.25 percentage points this time around and indicated that there was no discussion of a 0.5 rise and in fact two of the seven voting members of the Monetary Policy Committee wanted no increase at all. More than that, the Reserve Bank has not lifted its prediction of a 5.5% peak in the cash rate.
What does that mean? It means that in order for interest rates to rise higher than they already are some new bad news is going to have to appear on the inflation outlook. That seems fairly unlikely.
For instance, just a few hours before the Reserve Bank undertook their review Statistics NZ announced that the volume of retail spending in New Zealand fell by 1.4% in the March quarter. This was substantially weaker than the average 0.2% rise which forecasters had been expecting. Consumer spending is weaker than anticipated.
This is important because weakness in household spending is the prime method by which the Reserve Bank seeks to get inflation down. It noted some weakness in consumer spending and then seemed to make some effort to note a whole lot of other things moving in the direction it wants.
For instance, it explicitly noted that the 0.6% shrinkage in the economy in the December quarter was unexpected (it had predicted a 0.7% increase). The Reserve Bank also noted that the March quarter inflation number was less than it had expected and that the short term upward pressure on prices as a result of recent flooding events has also proved to be less than it had anticipated.
The Reserve Bank noted weakness in the house building sector, which it expects to continue, and also assessed the Government’s budget as being contractionary, and therefore disinflationary, only slightly less so than it assumed in its February economic update.
It also noted that wages growth is slowing down and employers are finding it slightly less difficult to find the staff that they want.
Put it all together and what we have is that the financial markets in recent weeks have somewhat got carried away with a pessimistic view on inflation which the Reserve Bank does not share. Our central bank is certainly not talking about interest rates coming down in the near future and in fact project that it won’t be cutting the OCR until just before the end of 2024.
But given some of the results I can see in my surveys there is a very good chance it will start cutting monetary policy in the first half of 2024. That is not quite so important as what happens now. As a result of the latest monetary policy review, we are going to see more people falling into line with the view I’ve been expressing recently that mortgage rates in fact have already hit their cyclical peaks.
This doesn’t mean that they’re going to fall away anytime soon. But when people can see the worst case scenario, they can start looking through it and thinking about when interest rates go down. When we put the removal of a new shock interest rates scenario alongside slowly rising awareness of the boom in net migration inflows, slowly rising awareness of the tightening up of the rental market now underway, still good feelings of job security, and one day awareness that house construction is going to be falling over potentially a three-year period, and you get a turn around in the housing market.
We can say slightly more confidently now that we are in the bottom of the house price cycle and what’s likely to start happening now is the two year queue of people who have held off buying a property is likely to start stepping forward. I think the initial movement is going to be relatively minor because after all interest rates are still much higher then people have become used to in recent years.
But the cycle is turning and the pay off of more delaying for those who have been holding off making a purchase until prices go lower, now looks decidedly weak in the main cities.
– Tony Alexander is an independent economics commentator. Additional commentary from him can be found at www.tonyalexander.nz
