Signs inflation coming off: When might interest rates drop?

Monday, 16 January 2023

Reserve Bank governor Adrian Orr released the bank’s first monetary policy statement of the year against a backdrop of fresh economic uncertainty caused by Cyclone Gabrielle.

Falling inflation overseas is boosting hopes that price rises may also be near a peak here and that the heat could start to come off interest rates later this year.

Kiwibank chief economist Jarrod Kerr said that the latest inflation figures from the United States were “playing out just as hoped”.

The US Bureau of Labor Statistics reported late last week that annual inflation in the US had subsided to 6.5% in December, down from a 40-year high of 9.1% in June.

The Reserve Bank tipped in November that annual inflation here would climb from 7.2% to reach 7.5% in the December and March quarters.

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Its November forecast also implied that the official cash rate (OCR), which is currently 4.25%, would climb to about 5.5% by June and stay at about that level for a year.

But Kerr believed inflation was close to its peak, if it had not already peaked, and that the Reserve Bank would be cutting interest rates before the year was out.

About half of the inflation New Zealanders had experienced had come from overseas and he held out hope inflation could fall to 4% by the end of the year.

“I think that'll be the big story for the second half of this year; central bank's not only finishing hiking, but actually starting to provide some support.”

BNZ said in an update on Monday that it believed the labour market was “about to turn” and that there was a “strong chance” that the Reserve Bank could get a shock by annual inflation coming in below its 7.5% forecast when Stats NZ reports the December-quarter number on January 25.

It is currently tipping Stats NZ will instead report a small dip in inflation to about 7.1%.

In the recent past, the Reserve Bank had adjusted its monetary policy stance immediately, if it found it had underestimated inflation and “to be consistent” the central bank should adjust its forecast of future interest rates if inflation instead came in lower than expected this time, BNZ said.

If BNZ was right about inflation the Reserve Bank should back away from raising the OCR by 75 basis points when it issued its next monetary policy statement in February and instead settle for a 50bp raise, it said.

“But for this to happen we would have to assume our inflation forecasts are correct, the Reserve Bank behaves symmetrically with regard to downside shocks as it does upside, there are no other factors that offset the shock and it doesn’t ‘look through’ any downside surprise,” it added.

“In short, we are fairly confident fourth-quarter inflation will come in below the Reserve Bank’s forecasts … but what we are less confident about is how the Reserve Bank will respond.”

Kerr cautioned that while there were “some very positive, encouraging signs inflationary pressures are easing” with the improvement in supply chains and China opening back up again, there were also some “frustrating or awkward undercurrents” going the other way on inflation.

These included rising food prices and “some other commodity prices just not playing ball”, he said.

“We've gone from consuming a lot of goods to now consuming more services and service-type inflation is picking up a bit, which doesn't help.”