ANZ believes Reserve Bank may plot track to 4.5% official cash rate on Wednesday

Friday, 12 August 2022

What will the Reserve Bank of New Zealand do next?

The Reserve Bank will probably raise the official cash rate by 50 basis points to 3% when it releases its next monetary policy statement on Wednesday, economists agree.

But differences are emerging between them on whether it will ratchet up or perhaps start to introduce more nuance into its recent more hawkish rhetoric.

Though both expected a 50bp rate rise, ANZ bank is not ruling out a 75bp hike, while credit ratings agency Moody’s said it would not be surprised if the bank settled for a smaller 25bp raise, highlighting the different takes now being made on the economy.

The Reserve Bank kept the blinkers on inflation when it last raised the official cash rate (OCR) to 2.5% in July, bar briefly acknowledging there were “emerging medium-term downside risks to economic activity”.

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ANZ chief economist Sharon Zollner is forecasting the Reserve Bank could strike an even more hawkish tone this time by signalling it now expects the official cash rate to peak up to 50 basis points higher than it previously forecast.

The Reserve Bank will release its next monetary policy statement against the backdrop of renewed criticism it did too much to fuel inflation earlier on in the Covid pandemic.

That would imply the OCR would hit 4.5% next year, which would be a major change from the central bank’s May forecast which indicated the rate was likely to peak at 4%.

“The Reserve Bank will publish the OCR track that sends the message that they want to send and we think they will want to send a message that they are not nearly done,” Zollner said.

But BNZ research head Stephen Toplis said that while nothing could be ruled out, it was “absolutely certain” that inflation in New Zealand had now peaked and there appeared to be insufficient reason for the central bank to do anything other than fine-tune its previous OCR outlook.

Wednesday’s monetary policy statement comes hot on the heels of a fresh barrage of flak from former governor Graeme Wheeler and others over the looseness of monetary policy earlier on in the Covid pandemic.

Toplis said central bankers “were only people”, who could not help but be impacted by criticism, but it was not clear why they would change what they were doing now based on criticism of what they did “some time ago”.

Global inflationary pressures appear have started to ease off, with annual inflation in the United States dropping a little to 8.5% in July, and Toplis noted there had been a strong pullback in many commodity prices from their highs at the start of Russia’s war on Ukraine.

Sharon Zollner says prices are too high but that doesn’t mean they can’t rise.

In New Zealand, the price of 91-octane petrol has fallen about 15% since June, from a little above $3 a litre to about $2.60, which Toplis said was important both in itself and because the price of fuel was “one of the single biggest drivers of inflation expectations and sentiment”.

Similarly, labour market figures reported by Stats NZ earlier this month, which showed a small up-tick in unemployment, were marginally weaker than the Reserve Bank had expected, he said.

The only thing that had materially changed since the bank’s last statement was that global economic activity was likely to be weaker than previously thought, he said.

But Zollner said that with floating mortgage rates still sitting below the rate of inflation, which was last measured in the June quarter at 7.3%, and private sector hourly earnings rising at the rate of 7%, the Reserve Bank could not claim it was a case of “job nearly done” on inflation.

“Even if inflation is falling, if it is not falling fast enough then the OCR is going to have to go through 4% and carry on in order to offset that erosion of the monetary tightening that they have delivered that is due to household incomes going up.

“You just imagine a scenario where wage growth keeps growing at 7% and interest rates stay where they are and then, over time, people are going, ‘oh, actually, that doesn't look so bad in the context of my new higher income, maybe we will redo the kitchen’.”

The extent to which wage rises could be said to be driving inflation has become increasingly contentious in the wake of evidence of soaring company profits.

Stats NZ reported earlier this month that average ordinary hourly earnings among all workers, including public sector employees, as measured by its Quarterly Employment Survey (QES) rose at the annual rate of 6.4% in the June quarter, which was below the annual inflation rate.

Its raw measure of labour-cost increases, at 5.1%, was lower than the QES figure by an unusually large margin and the rise in its estimation of labour costs fell to 3.4% once it adjusted that for factors that it assumed would reflect higher productivity.

First Union policy analyst Edward Miller accused economists of running a false narrative on wage inflation earlier this month, saying that while they were busy trying to argue that Stats NZ’s figures were evidence of a wage-price spiral, that case was “poorly laid out”.

Council of Trade Unions economist Craig Renney also said wage rises were still playing “catch-up” with inflation, not driving it.

Toplis agreed it was “premature” to say there was such spiral.

“It is not premature to conclude that wages are rising because inflation is rising but a wage-price spiral means that wages are rising and inflation rises again and it keeps going up.

“But my suspicion is that as you start to see inflation drop away, that will also feed through into wage expectations.”