- The RBNZ cut the official cash rate by 50bps to 4.75%, as we expected. It follows the 25bp cut at the August MPS. We expect another 50bps cut in November. The Kiwi economy needs it. And there’s a long gap until they meet again in 2025.
- The Kiwi economy continues to operate below its productive capacity. Spare capacity is building. There’s further disinflation pressure to come. The case for maintaining restrictive policy is done. We need a full reversal back to neutral, and that’s below 3%.
- The market reaction was relatively muted given that the outsized move was largely priced. An already soft Kiwi dollar was pushed slightly lower, and wholesale interest rates were little changed.
We've seen more tacking and jibing from the RBNZ than you’d expect to see out of a foiling AC75 Americas cup boat. After coming off their foils in May, the RBNZ headed downwind in July, with a tactical change in sails. The manoeuvre enabled them to cut in August, regaining speed, and respect. The nosedive in May, long forgotten. And now they’ve gained speed by cutting 50bp. The spectators on the rocky shores, delighted at their progress.
As the RBNZ gains knots on the race course, the knots in traders stomachs, were untied. Those calling for 50bps today were rewarded. It’s always super simple in hindsight, but there were plenty of nerves going into today’s announcement. It won’t get much attention, but the RBNZ has snuck back in below the Fed, which should help with the Kiwi currency. The Fed delivered a 50bp move to 5% (from 5.5%), leapfrogging the RBNZ’s earlier 25bps move to 5.25%. Well now, the RBNZ is at 4.75%, putting their nose back in front.
Having reached an annoying peak of 0.6374, at the start of October, the flightless Kiwi has dipped back below 61c (at time of writing). We may, we just may, see the low of 0.5861 again (last traded on 30th July). Indeed, our year end forecast is 0.59c, and today’s move by the RBNZ certainly helps that call.
Accompanying the press release, the RBNZ also published the Summary Record of Meeting. And a key line in the ROM was: “Members agreed that increasing excess capacity is leading to lower inflationary pressure in the New Zealand economy” (RBNZ, Oct24). Back in August, the RBNZ noted: “increased spare capacity” (RBNZ, Aug24). Forgive us for getting grammatical, but it’s a subtle yet important switch in verb tense – from “increased” to “increasing”. And it tells us that, like us, the RBNZ is seeing a continued build up in spare capacity in the economy. And that means more disinflationary pressure to come. Recent pricing indicators are tilting the balance of risks towards inflation falling below 2%. As the latest NZIER survey revealed, a declining share of firms have and are indenting on raising their prices.
The ROM also revealed that a 25bps cut was considered. But the RBNZ settle on a 50bp cut, as it was deemed the “most consistent with the Committee’s mandate of maintaining low and stable inflation, while seeking to avoid unnecessary instability in output, employment, interest rates, and the exchange rate” (RBNZ, Oct24). Given market pricing, a 50bp cut was always going to be the scenario resulting in little market reaction – as was the case. Instead we suspected that a smaller cut would be the move to set off the fireworks. Given today’s result, the RBNZ was also weary of causing unnecessary market volatility.
Measure twice, cut twelve times. We need a neutral rate
The case for keeping policy settings at restrictive levels has quickly evaporated. Inflation is projected to be closer to the middle of the RBNZ’s 1-3% target band than we previously forecast. But the cash rate is currently set at levels when inflation was at 6%. Policy needs to return to more neutral levels and soon to stay ahead of a deeper downturn in the economy.
Restrictive interest rates have done enough to depress domestic demand. Since the end of 2022, we have been in recession. We’ve recorded a triple dip recession, with another contraction likely in the September quarter. On a per head basis, we’ve recorded a deep 4.6% decline, worse than the 2008 GFC.
Spare capacity is building in the economy. Unemployment is on an upward trajectory. We forecast the unemployment rate exceeding 5% by year-end. The labour market lags economic activity by about 9 months. So, there is more pain to come. With greater spare capacity comes further disinflation pressure. That’s needed. Because domestic inflation is still too high. A fast deceleration in imported prices has done most of the hard yards in bringing down headline inflation, from 7.3% to 3.3%. But that work will be sustained by the eventual normalisation in domestic price pressures.
With the economy operating below its productive capacity and inflation quickly cooling, the RBNZ needs to lift its foot off the brake.
Market reaction
Leading into today’s decision, the wholesale rates market had 43bps (85% probability) priced in at 4.82%. The RBNZ’s next announcement in November had another 50bp mostly priced at 4.37% (88bps of 100bps). That’s now fallen to 4.30% priced – a 90% probability of a follow-up 50bp cut. The market got it right. Market pricing is little changed, and so too are wholesale interest rates. The pivotal 2yr swap rate is still trading at around 3.66%.
On currencies, the Kiwi was hovering above this month’s lows heading into the RBNZ’s announcement. It’s a Greenback story following extensive Fed re-pricing. The Kiwi’s losses deepened after today’s decision. But it wasn’t a major move lower. Because the decision was largely priced. The Kiwi fell a little over 30pts to just under 61c from 61.30c prior to 2pm. The Kiwi posted a deeper slide against the Aussie dollar, down 50pts.
As our latest FX Tactical presents, we expect the Kiwi to remain in a broad downtrend in the next 3-6 months. The speed and magnitude of expected easing (rate cuts) underpins our exchange rate forecasts. And we expect the RBNZ to deliver a more aggressive cutting cycle than its peers. We hold a similarly bearish view for the Kiwi dollar against the Euro, Sterling, and most especially the Yen and Aussie dollar.
RBNZ statement
The Monetary Policy Committee today agreed to cut the Official Cash Rate (OCR) to 4.75 percent. The Committee assesses that annual consumer price inflation is within its 1 to 3 percent inflation target range and converging on the 2 percent midpoint.
Economic activity in New Zealand is subdued, in part due to restrictive monetary policy. Business investment and consumer spending have been weak, and employment conditions continue to soften. Low productivity growth is also constraining activity.
Some exporters have benefited from improved export prices. However, global economic growth remains below trend. The outlook for the United States and China is for growth to slow, while geopolitical tensions remain a significant headwind for world economic activity.
The New Zealand economy is now in a position of excess capacity, encouraging price- and wage-setting to adjust to a low-inflation economy. Lower import prices have assisted the disinflation.
The Committee agreed that it is appropriate to cut the OCR by 50 basis points to achieve and maintain low and stable inflation, while seeking to avoid unnecessary instability in output, employment, interest rates, and the exchange rate.
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