Bankers watching for any sign of recession nerves from Reserve Bank on Wednesday

Friday, 8 July 2022

Reserve Bank governor Adrian Orr discusses the risk of a recession in May.

Economists expect the Reserve Bank to hike the official cash rate by 50 basis points to 2.5% this week.

But just as important for many homeowners will be whether governor Adrian Orr publicly acknowledges any fears that an expected global economic downturn could have a stronger knock-on effect here than it has previously expected.

The Reserve Bank has already doubled the official cash rate (OCR) to 2% this year after announcing double hikes in April and May.

The country’s biggest bank, ANZ, is forecasting that it will be an “easy decision” for the central bank to follow that up with a third 50bp rise at its next monetary policy review on Wednesday.

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But while April’s rate hike was described as a “dovish” raise by some commentators because the bank indicated it was simply front-loading already-expected rate rises, it surprised the market by setting a much more “hawkish” tone in May that emphasised a very narrow focus on bringing down inflation.

With fears growing of a looming recession in Europe and the United States, and risk of contagion in New Zealand, the bank could opt for a more nuanced tone on Wednesday – though economists are not assuming that’s a given.

The central bank won’t have an opportunity to update the current forecast it made in May that the OCR would probably climb to 4% next year, before starting to come down towards the end of 2024.

So any revision to its expectations will need to be voiced in its commentary.

Its words could have direct bearing on home-owners’ finances.

Although the expected change in the OCR would be likely to flow through quickly into mortgage rate rises for those on variable or short-term loans, longer term rates may move more on the sentiment set by the bank.

ANZ, BNZ and Westpac all trimmed their two-year mortgage rates last week in response to a drop in wholesale rates triggered by the darkening economic mood.

Sharemarkets have taken a dive and house prices are rapidly retreating from their highs, but ANZ chief economist Sharon Zollner said it was “too soon for the Reserve Bank to blink just because asset prices are wobbling”.

She assumed the bank would decide it needed to raise the OCR to 2.5% because of the lack of evidence that inflation pressures were easing yet, and a labour market which she described as “incredibly tight”.

Zollner expected the Reserve Bank would transition to more sedentary 25bp rate hikes from October, but only if there were no upside surprises on inflation.

BNZ research head Stephen Toplis is also expecting the Reserve Bank to raise the OCR by 50bp “with a pledge to do more”.

“It’s hard to see how the Reserve Bank can produce a July Monetary Policy Review that is meaningfully different to its May Monetary Policy Statement,” he said.

“That said, we are strongly of the view the outlook for the real economy has deteriorated relative to that which the Reserve Bank based its May rate track on.”

The main domestic indicators of economic activity were looking “plain ugly”, he said.

“At the top of the list is the record weakness in consumer confidence.

“This must surely portend future softness in consumer spending, which accounts for almost two thirds of GDP.”

Business’ falling expectations of future profits were also a good indicator of where activity, investment and hiring intentions were heading, Toplis said.

House prices had fallen 7.7% and looked likely to fall “at least that much again”, he said.

Those developments might normally lead to an easing of interest rates, but it wasn’t growth, activity or the property market that was at the forefront of the Reserve Bank’s targeting regime, he noted.

“Instead, employment and inflation rule the roost.”

Toplis said if BNZ was in charge it would probably argue for the Reserve Bank to be taking a cautious approach, but it would be “gobsmacked” if the central bank didn’t opt for a 50bp rise.

”What will be of most interest to us will be any sign that the Reserve Bank might be contemplating softening its stance down the track.”

Westpac acting chief economist Michael Gordon noted that financial market pricing suggested investors had been flirting with the possibility of a 75bp rate rise, but said the expectation of a 50bp rise was “more or less unanimous”.

He also voiced concern that the Reserve Bank could end up raising rates too far, too fast, given the worsening economic outlook.

“Certainly there needs to be some kind of slowdown in order to bring inflation pressures into line.”

But the time lags involved with monetary policy meant that the risk of “overdoing it” was genuine, he said.

On the other hand, showing any lack of resolve on inflation now would risk undermining the work the bank had already done to dampen inflation expectations, Gordon said.

“For that reason, we think that for now the Reserve Bank will carry through with the OCR tightening path that it laid out in May without bowing to the speculation about recession risks.”