Should prospect of recession make Reserve Bank more cautious on OCR?

Tuesday, 4 October 2022

The Reserve Bank of Australia threw the cat among the pigeons by only raising its official cash rate by 25 basis points on Tuesday, on the eve of the New Zealand Reserve Bank's review of its OCR on Wednesday.

BNZ research head Stephen Toplis said the Australian central bank’s decision to only raise its key interest rate to 2.6% was a surprise.

The OCR track published by New Zealand’s Reserve Bank in August and relatively dovish comments made in recent speeches by governor Adrian Orr would not appear obviously inconsistent with a 25bp rate rise on Wednesday.

But Toplis said it would be a bigger, huge surprise if the Reserve Bank opted to follow Australia and eschew the 50 basis point rate hike that analysts, including BNZ, almost unanimously expect to take the OCR to 3.5% on Wednesday.

* Official cash rate expected to rise to 3.5% on Wednesday

* Global recession risk: why the worry and what to watch for

Justifying its smaller-than-expected 25bp rate rise, the governor of the Reserve Bank of Australia, Philip Lowe, said the cash rate in Australia had “increased substantially in a short period of time” and explained that while it expected further rate rises, it was assessing the outlook for inflation and economic growth.

Toplis said the Australian decision had probably come too late to influence the Reserve Bank’s monetary policy review.

Reserve Bank governor Adrian Orr speaks with Stuff a day after raising the official cash rate in August. (Video first published August 18, 2022)

Even so, Toplis said the Australian decision still sent a strong message.

The prevailing view was that the New Zealand Reserve Bank would need to get more aggressive to match rate rises elsewhere as central banks sought to avoid inflation “getting away”.

But that ignored the risks on the flipside, he said.

“As you look around the world, the extent of the tightening that we see, coupled with the ‘disaster’ that is the UK and Europe means there is a reasonable chance the world will go into recession.

“The last thing that central banks will want to be doing is tightening really aggressively to thwart past inflation pressure when they are staring down the barrel of something that might generate significant deflationary pressures going forward.”

There was a long lag between growth slowing and that showing through in reduced inflation, but there was also a lag in interest rates rising and that affecting the economy, Toplis said.

“What we're doing now will still be impacting the economy in 18 to 24 months’ time.

“Do any of us really believe the economy is going to be going gangbusters in 18 months’ time? Because I don't see anyone forecasting that.”

Financial markets are currently assuming the official cash rate is most likely to peak at 4.75% next year, which is far higher than the Reserve Bank’s own predictions in August which suggested the OCR was most likely to peak at 4%.

Toplis said it was possible the Reserve Bank might surprise the market on Wednesday by reaffirming the OCR track it had laid out in August.

“If it reaffirms its August view, that is actually quite dovish relative to market pricing,” he said.