Taking the OCR path of least resistance while Kiwibank begs for a halt on hikes

Economists and the financial markets believe another 0.25% OCR hike to 2.75% at next week’s RBNZ Monetary Policy Statement (MPS) meeting is a done deal.

However, Kiwibank is the lone voice in saying rates hikes should stop until after the election.

“Interest rates should remain stimulatory for now, to entice and encourage investment and hiring, Jarrod Kerr, Kiwibank chief economist says.

“The economy needs support, and inflation pressures should ease from here.

“If it were up to us, we would have left the cash rate at 2.25% in July and looked to commence tightening after the election.”

He says uncertainty kills growth. And the heightened uncertainty from the war in the Middle East is causing many businesses to delay or cancel projects, and households to adjust spending patterns.

“Delayed spending may have caused a contraction in activity over the second quarter of this year and the third quarter is not looking much better.

“It reminds us of 2024 and 2025. The economic recovery has hit yet another speed bump.”

Kerr says it is a supply shock that is causing demand destruction.

Oil inventories are being drawn down slowly, but the price is having an impact. There has been significant demand destruction in poorer Asian countries, and across Africa.

“The poor demand less, as the rich pay the higher price. That theme is playing out within New Zealand as well. Poorer households suffer more.”

The so-called cost-of-living crisis (following food, rates, insurance and many other price hikes) continues to frustrate businesses (unable to pass it on) and restrain households (unable to keep up), he says.

“It is simply too early to assess the inflationary pulse, and the likely unwind. It is too early to gauge the impact on demand. And it is too early to see the adverse effects in the labour market. Therefore, it’s too early for the RBNZ to hike.”

Three key arguments for hikes

ASB senior economist Mark Smith says the RBNZ will take the path of least resistance on Wednesday and hike the OCR to 2.75%. 

The three key arguments supporting a 0.25% hike are a high inflation starting point, a low starting point for the OCR, and acting to avoid unnecessary volatility, he says.

“It will be of little surprise for the September Monetary Policy Statement’s (MPS) to show projections of annual CPI inflation falling below 3% by early next year and converging to the 2%  inflation target midpoint thereafter.”  
Smith says the bank expects the OCR to end this year at 3.25% as remaining monetary stimulus is withdrawn.

It sees two-sided risks, ranging from a more gradual rate of policy tightening and lower OCR 
peak versus a higher 2027 peak than 3.25% if inflation proves stubbornly high.

Bigger rise predicted

While the central bank is expected to signal more rises to come next week and an OCR peak approaching 3.5%, Stephen Toplis, BNZ research head thinks what the RBNZ publishes on Wednesday and what eventually is the case will be slightly different.

 “It is our view the cash rate will rise 0.25% at each meeting until it reaches 4% in May next year.”

Toplis says so much will happen between now and mid-next year that could alter this outcome but the risks are both ways, with four big potential downsides – El Nino causing a recession; election uncertainty delays the expected economic recovery; a global asset price correction triggered by any combination of further geopolitical ructions, a technology stock driven revaluation of equity markets and rising interest rates; a change in government seeing a change in the RBNZ’s mandate that not only brings employment back into the frame but does so in a manner that impacts the way the central bank sets rates.

On the flip side, he says inflationary pressures continue to build; some of these are structural in nature but central banks still choose to respond to them; and a multiplicity of factors cause potential output growth to fall more than anticipated.  

“In trying to ascertain what the RBNZ might do we are somewhat torn between points of comparison with the extensive data published in the May Monetary Policy Statement and the very partial updates provided in July. In the end, as partial as it might be, it is the July missive that matters more.

“With that in mind, the critical sentence in the July media release is: ‘With inflation still above target and economic activity expected to strengthen, some further reduction in monetary stimulus is likely to be required to return inflation to the 2% target mid-point’.

“Well, inflation is still above target and likely to stay above the target band, let alone the mid-point, until the second quarter of next year. Moreover, we are projecting annual CPI inflation of 3.7% for the September quarter this year compared to an RBNZ projection, of 3.3% for the period.

“To cap things off, it looks as if growth will be at least as strong as the RBNZ had been expecting.”

Toplis says the only thing that could conceivably provide the RBNZ with some reason to pause at next week’s meeting is the unemployment rate being higher than anticipated. “But with employment also higher than expected and the Labour Cost Index a tad more inflationary we don’t think the state of the labour market is due cause to blink,” he says.

Data dependent approach

Westpac sees the RBNZ being equivocal about the potential for an October OCR increase.

It seems likely to adopt a data dependent approach to determining whether to continue raising rates in October, given they will be close to the 3% neutral rate level the RBNZ often emphasises, and there is a lot of data due for release over September and October, Kelly Eckhold, Westpac chief economist says.

“We tend to think there won’t be much of a shift in the RBNZ’s OCR forecasts given the significant uncertainties at present.”

He says the strategy to return the OCR to around 3% by year-end seems clear and uncontroversial.

“It’s unclear that further increases will be required at every remaining meeting for the rest of the year. The economic recovery remains fragile and significant risks abound.”

Eckhold says care should be taken to not take the recovery for granted – especially while the improvement in the labour market remains embryonic.

“Core inflation remains too high, and I remain sceptical that inflationary supply shocks will dissipate either quickly or sustainably.

“Hence, it’s likely that higher interest rates will be required through 2027 once the economy is sustainably operating above trend and the labour market is recovering.”

He says a RBNZ data-dependent approach is appropriate.