Inflation at 2.5% and OCR at 5.75% next December?
Fast-forward to December next year and if the Reserve Bank’s latest forecasts are to be believed, the economy will be in quite a different place.
The economy will still be growing at the tepid rate of 1.6% but annual inflation will have fallen to 2.5% – back within the Reserve Bank’s target band after being on the retreat for 2½ years – while unemployment will have just climbed to 5.1%.
Despite that, the official cash rate will be 25 basis points higher than it is today, at 5.75%, with the Reserve Bank yet to respond to any of the above trends by beginning its easing cycle.
If that comes to pass, with the key cash rate 3.25% above inflation, it should be good time to have savings in the bank.
Reserve Bank chief economist Paul Conway acknowledges that financial markets aren’t yet fully buying into the scenario. Kiwibank chief economist Jarrod Kerr notes that at the moment traders are still pricing-in two interest-rate cuts late next year, much sooner than the Reserve Bank is signalling.
But Conway denies the Reserve Bank was just talking tough for effect in the forecasts it issued alongside its monetary policy statement last Wednesday, saying the bank “isn’t playing a game”.
The bank’s monetary policy committee is “impatient” to get inflation back into its target band of 1% to 3% and yet there are upside risks to inflation, he says.
“What we're saying in the statement is that we don't see the scope for rate cuts until into 2025.
“We need to be sure that inflation is not only not just ‘sort of dipping’ into the band, but is firmly anchored at that midpoint of 2%. I would say that 2.5% is not job done; our job is to get inflation back to 2%.”
Conway suggests that in hoping for earlier cuts, financial markets may be too influenced by sentiment overseas, where analysts are “latching on to any sign” that the loosening cycle has begun, and that an element of groupthink may be at play.
“We had a global shock in the form of the pandemic and the response from central banks was broadly quite similar across the globe. But I think we are going back into a period when idiosyncratic economic developments across countries are becoming more important as the effects of that shock wash out of the data.”
One of those idiosyncrasies is record net migration, he says.
Stats NZ’s initial estimate is that the country attracted a net 118,800 migrants in the year to September.
Having previously characterised migration as a mixed bag for inflation, the Reserve Bank largely focused on the “demand-side” implications, such as extra demand for rental accommodation, in its Wednesday statement.
Conway says the bank has been researching the migration trend and is still of the view that the current wave of migrants may contribute less to inflation than those in the past.
“A migrant who comes on a short-term work contract and is staying in a dormitory and remitting most of their salary back to their home country is going to have a very different effect to a migrant who's coming with a family and needing to buy a house and a car and so on.”
But it has been a “huge inflow”, he says. One of the reasons inflation has fallen faster in the United States than here is housing, and that is because of the migration surge, he says.
“It's kind of ludicrous for markets to go ‘well, inflation has dropped in the US, so why aren’t central banks everywhere, contemplating cutting rates’ because we're a different economy. Migration is probably the most obvious difference, but it’s only one of many.”
BNZ research head Stephen Toplis sees a risk that markets may be discounting the chance of further rate rises because they see the Reserve Bank’s rhetoric as “jawboning” when in fact the central bank is being clear and sincere.
“The message from the Reserve Bank is that it seems to have little tolerance of upside inflationary surprises. We are not sure markets have fully heeded these messages.”
But despite that, BNZ is still tipping rate cuts next year – just starting in August rather than in May.