Bank's prediction comes after latest 25-basis point rise
Following the Reserve Bank’s 25-basis point hike that took the official cash rate to a 15-year high of 5.5%, from a record low of 0.25% in just 19 months, Kiwibank economists now say the central bank “looks to be closing the current chapter of fast-paced monetary tightening”.
In Kiwibank’s latest publication, senior economist Mary Jo Vergara (pictured above left) and chief economist Jarrod Kerr (pictured above right), said the new OCR track maintained 5.5% as the forecast peak, just as they had hoped. The pair had for a long time flagged the risk of overtightening.
“Most economists had changed their view in the week leading up to the May MPS (Monetary Policy Statement),” Kerr and Vergara said. “Further tightening above 5.5% was (and continues to be) argued due to the recent surge in net migration and reveal of a more expansionary government budget.”
“The RBNZ, however, countered this argument, noting ‘Relative to the February statement, higher net migration, a slower decline in house prices, and higher government spending are offset by the lower starting point level of GDP and consumer price inflation as well as a more negative outlook for our goods and exports’.”
“Indeed, the recent flow of data has been weaker than expected. Inflation surprised on the downside (6.7% vs RBNZ’s 7.3% forecast), the critical two-year ahead inflation expectation print is back within the RBNZ’s 1-3% target band, and confidence among businesses and households remains subdued. The latter suggests weakening economic activity. Household consumption, in particular, has cooled and retail sales are contracting as a result (see COTW).”
The Kiwibank economists said the economy had clearly softened and was tipped to soften further, with demand being dragged down by surging interest rates.
RBNZ slightly revised its growth forecast higher, with economic activity predicted to contract by a cumulative 0.3% over two quarters by the middle of this year, with rather flat growth heading into 2024. For inflation to return to target, they said the economy required rebalancing through “demand destruction”.
With a flat OCR track at 5.5%, Kerr and Vergara said RBNZ presented a much more dovish outlook than anticipated.
“The reaction in rates and currency was dramatic and immediate,” they said. “OIS (OCR) pricing was steamrolled lower. The peak in the OIS strip has dropped from 5.94% to 5.56%. The readjustment in pricing pulled down short-term wholesale swap rates.”
“The all-important two-year swap rate is currently trading at 5.26%, down more than 30bp from the 5.59% pre-MPS high. It’s a big drop, but unlike in April, the RBNZ won’t be too concerned. Because short-term rates have simply returned to pre-budget levels which are still well above levels early in April. Reaffirmation of the OCR track has set a floor under wholesale (and therefore retail) rates.”
They also noted that the Kiwi currency had fallen more than 2c since the MPS, although this was partly due to the recent strength in the USD.
“The NZD is currently trading at around the 0.6050c mark,” the economists said.
“If this is peak in the cash rate, we expect to see further falls in the Kiwi from here. Our long-held forecast for the Kiwi is 0.55c by year-end. A softer terms of trade (export prices), weakening growth, and compliant inflation means lower interest rates and narrowing rate differentials.”
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