Rate of inflation drops: What does this mean for interest rates?

Thursday, 20 April 2023

Reserve Bank deputy governor Christian Hawkesby discusses inflation in February.

A drop in the rate of inflation is likely to mean the official cash rate (OCR) is near its peak, but economists expect there could be one more increase to come.

Inflation at 6.7% in the three months to March was significantly lower than the market, and Reserve Bank, predicted.

The drop was entirely due to the influence of imported inflation, including fuel prices.

The Reserve Bank has been hiking the OCR to get inflation under control. It is currently at 5.25% and the Reserve Bank forecast a peak of 5.5% but some economists had thought it would need to increase to 5.75%.

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Chris Tennent-Brown, senior economist at ASB, said the inflation data made his team more comfortable with its forecast that the OCR was almost as high as it needed to go.

“On balance, we expect a further 25 basis point (bps) OCR increase in May, with the Reserve Bank needing to impose restrictive OCR settings for a concerted period to push inflation lower. However, today’s CPI report suggests that past OCR hikes are gaining traction.”

Tennent-Brown said there could be more upward pressure on floating and short-term home loan rates but long-term rates were now as high as they would go.

ASB and Westpac have both increased the interest rates charged on shorter terms but lowered the rates for longer fixes in recent days.

It’s not clear whether slower inflation will alter the Reserve Bank’s interest rate course.

“OCR cuts will only be contemplated when sub-3% CPI inflation is in prospect, but this is unlikely to be seriously considered until well into 2024 – until then we expect the shorter terms to remain high, and the borrowing curve to remain inverted, with long-term rates lower than some of the shorter terms.”

Jarrod Kerr, chief economist at Kiwibank, said he thought the Reserve Bank should pause any further increases now. He said market traders were already focusing on when cuts would come, which was restricting the extent of retail interest rate increases.

BNZ economists agreed the Reserve Bank had done enough already in terms of interest rate increasing.

“But we’ve had that view for a while now and it has clearly not been shared by the central bank,.”

They said there was nothing in the data on Thursday to indicate the Reserve Bank should take a more aggressive stance so it should help rule out a 50bps increase at the next meeting.

“We thought the weaker-than-expected GDP last time around should have been more influential but at least today’s data is a direct measure of inflation. Is it enough for a pause? Moot point. But it should now be close to a 50/50 call.”

But at ANZ, senior economist Miles Workman said he was not convinced the CPI data was enough to “shift the dial” on the track of the OCR.

“All else equal, the Q1 CPI alters the balance of risks towards less tightening being needed overall but not enough in our view to make a pause in May more likely than a 25bps hike. It should, however, rule out another 50bps hike.”

Kelly Eckhold, Westpac chief economist, said there was still “a bit of water to go under the bridge”. “This is probably not enough to shift the general stance of the bank.”

The bank was still facing the prospect of higher inflation than it was comfortable with for some time.

He said he expected one more increase and then rates to remain on hold.

“What would give them a lot of comfort is if the labour market data in a couple of weeks starts to show the labour market weakening.”

He said the Budget was another variable that it would have to consider because that could involve more spending.

Brad Olsen, chief executive at Infometrics, said the Reserve Bank would be worried about domestic inflation that had reached record levels.

“I definitely don't think it suggests to them the battle is over. A lot of the heavy lifting has been done with interest rates but if I was the Reserve Bank I would be happy to say it's completely and utterly done.”

But he said retail rates were at or very close to their peak position and there would be less pressure on them in future. He said longer-term rates reducing reflected that it was a time when, if people were worried about rates, they could be “tricked” into fixing for a longer period.