RBNZ Expected to Implement 50bps OCR Cuts in October and November 2023

The Reserve Bank of New Zealand (RBNZ) is anticipated to announce a significant reduction in the Official Cash Rate (OCR) by 50 basis points during its upcoming Monetary Policy Review in October, bringing the rate down to 4.75%. Following this, another 50bps cut is expected in November, which would further lower the OCR to 4.25%.

The decision to accelerate the pace of easing in October appears to be a finely balanced one, with a probability of around 60%. However, the likelihood of a more substantial easing in November seems considerably higher. This shift in monetary policy is influenced by the current inflation outlook, which is projected to stabilize around 2% starting from the third quarter of 2024. This provides the RBNZ with the flexibility to adjust the OCR more rapidly towards neutral settings.

Our revised forecasts indicate that the OCR will move towards neutral levels more swiftly than previously anticipated. The expected cuts by Christmas will bring the OCR closer to the long-term neutral rate of 3.75%. The RBNZ's stance reflects a cautious approach, as there are emerging signs that the economy is responding positively to the current easing conditions.

Looking ahead to 2025, we predict a slower, data-dependent reduction in the OCR. We have factored in 25bps cuts in both the February and May Monetary Policy Statements, aiming for the terminal OCR of 3.75% by mid-2025.

A key factor driving this change in outlook is the improved inflation profile, which appears to be more favorable than what was observed since 2021. Our current inflation forecast for Q3 stands at 2.4%, with a slight decline to 2.2% anticipated in Q4. Recent data from the Quarterly Survey of Business Opinion (QSBO) supports a benign view of short-term pricing pressures, suggesting that the RBNZ may not face significant obstacles in adjusting the OCR towards neutral levels.

Additionally, the global interest rate cycle has shifted in recent months, with central banks responding to a worldwide inflation shock. The RBNZ is now aligned with other advanced economy central banks that have already implemented significant easing measures and are poised for further reductions by the end of Q1 2025. Given that inflation is projected to remain close to target and the economy is operating below its productive capacity, there is less justification for maintaining restrictive monetary settings.

As discussed in our recent analysis, there are valid arguments for both maintaining a gradual easing pace and accelerating the return to a neutral policy stance. However, current data leans towards supporting a more dovish approach. While non-tradable inflation remains high, the easing of financial conditions could lead to a quicker economic rebound, potentially complicating the disinflation process. Nevertheless, the latest QSBO indicates that economic momentum may still be negative in the near term.

The housing market is showing signs of increased activity, yet prices remain depressed, suggesting that a recovery may not materialize until 2025. The positive outlook for the primary sector could bolster the economy, but this is likely to be a consideration for 2025 as commodity prices recover from low levels.

In summary, the RBNZ's Monetary Policy Committee is likely to ponder, "What are we waiting for?" when evaluating the rationale for maintaining the OCR at relatively tight levels. If the answer is minimal, the path forward appears clear, especially with a significant gap between meetings from November 2024 to February 2025.

We previously believed that if a 50bps cut were to occur, the November Monetary Policy Statement would be the most opportune time, given the calendar gap. However, if the case for a November cut is strong, then an October adjustment also seems plausible. We do not anticipate that upcoming Q3 CPI or labor market reports will significantly alter the case for substantial OCR adjustments before Christmas. Should any risks arise, the RBNZ has the flexibility to adjust the OCR by a smaller margin in November if necessary.

The challenge for the RBNZ will be to manage market expectations regarding OCR cuts. Moving the OCR closer to neutral will aid in this objective, but we also hope for clearer guidance on policy operations for 2025. Since 2019, monetary policy has been overly procyclical, necessitating tighter settings in 2023-24. The RBNZ should resist the urge to cut rates too aggressively in 2025 unless justified by the economic and inflation outlook.

Key developments since the August Monetary Policy Statement include:

• Activity: GDP contracted by 0.2% in the June quarter, slightly better than RBNZ expectations. Indicators suggest continued contraction in September, with subdued growth projected for December.
• Inflation Indicators: Monthly Selected Price Indexes indicate Q3 CPI inflation may align with the RBNZ’s forecast of 2.3% y/y, though survey indicators suggest potential downside risks.
• Labour Market: While job stability has been observed, the unemployment rate likely increased in September, consistent with RBNZ expectations.
• Sentiment: Business sentiment has improved significantly, particularly in the ANZ Business Outlook Survey, although consumer confidence remains modest.
• Housing Market: House prices have likely contracted further, with recent activity not sufficient to reverse the downward trend.
• Commodity Prices: Key commodity prices, especially in the dairy sector, have shown improvement, with Fonterra raising its milk price forecast.
• Global Growth: Weak data from China has prompted stimulus measures, but it remains uncertain if these will alleviate deflationary concerns.
• Financial Conditions: Domestic wholesale interest rates have declined, influenced by the Fed’s recent policy easing, while the NZ dollar TWI is trading above RBNZ assumptions, potentially impacting near-term inflation forecasts.