What will interest rates do in 2025?

Tuesday, 17 December 2024

From a high of 5.5% in July, three consecutive cuts reduced the official cash rate to 4.25% last month.

From a high of 5.5% in July, three consecutive cuts saw the official cash rate fall to 4.25% at last month’s review.

But economists say the Reserve Bank’s projected path for the OCR in 2025 is higher than expected.

The Reserve bank is expected to reduce the size of its cuts from 50-basis points to 25bp later in the year.

After years of rising interest rates, borrowers finally got some relief when the Reserve Bank took a knife to the official cash rate (OCR) this year.

From a high of 5.5% in July, three consecutive cuts reduced the OCR to 4.25% at last month’s review.

The Reserve Bank has cut the OCR by 50 basis points to 4.25%, offering relief to homeowners. While rates continue to drop, economic challenges like rising unemployment remain.

But how long will the cuts continue, and will the central bank keep up the pace of reductions?

Kiwibank chief economist Jarrod Kerr said despite the recent cuts, the Reserve Bank’s projected path for the OCR in 2025 was still higher than expected.

“According to the RBNZ’s OCR track, the cash rate finishes 2025 at 3.5%. That’s just 75bps of cuts over the entire year, of which 50bps is delivered in February. And the final move to 3% does not happen until deep into 2027. It’s a strange track.”

Kerr and his team had forecast a continuation of cuts to 3%, followed by a pause, and then a slightly stimulatory boost to 2.5%. However, that had since changed.

“Now we just expect the RBNZ to stop at neutral ‒ 3% ‒ where policy is neither stimulating nor restraining the economy. The RBNZ is more comfortable than we are with the economic scarring inflicted and likely recovery.”

And neutral was still a long way off, he said.

Kiwibank chief economist Jarrod Kerr says the Reserve Bank’s projected path for the OCR in 2025 is higher than expected. (File photo)

“At 4.25%, rates are restrictive, and we’re deep in recession. We’re at least 75bps off the more pessimistic estimate of neutral at 3.5%, and 175bps off the lower estimate of 2.5%. No one sees neutral at 4% or above.”

Although there was no discussion of a 25bp cut in the lead-up to last month’s review and the RBNZ had been “very vocal” about another 50-point cut in February, there was likely to be more talk of a 25bp move as the next review approached, Kerr said.

“A 25 may get more airtime then. We think the RBNZ will scale down to 25bp moves as the size of choice later in 2025, as they slow their approach to neutral.

Infometrics chief forecaster Gareth Kiernan said the RBNZ’s OCR track still suggested about a 65% change of a 50bp cut in February.

However, forecasts should be treated with “extreme caution”, given the bank’s own lack of faith in its previous forecasts, and with a lot of time and data to come before the next review.

“The bank still sees the OCR bottoming out at around 3% over the medium term, despite slower potential growth for the economy,” Kiernan said.

“There appears to be a degree of inconsistency between the bank’s assessment of slower potential growth and greater persistence in domestic price pressures, at the same time as they have opted to cut interest rates faster than previously indicated.”

Kiernan said a 50-point cut to the OCR was the most likely outcome at February’s review, although based on the November statement and the RBNZ’s economic projections, a 25-point cut would be most appropriate, he said.

“The long summer break will provide considerably more data to assess before then, so the decision remains highly data-dependant.

“In the meantime, financial markets could latch onto the bank’s latest forecast track and price in more cuts to the OCR than they had been. Such a shift could bring shorter-term fixed mortgage rates down further before Christmas.”

Westpac chief economist Kelly Eckhold said the RBNZ's assessment of the neutral rate was too low and little further easing would be required after early 2025.

The RBNZ had a strong presumption of a 50bps cut in February and Eckhold put the odds of a 25bp cut versus a 50bp cut in February as a 40:60 proposition.

Unless there was a new economic shock, cuts of 75bps were now off the table and the easing cycle was likely to end by mid-2025, he said.

“If the RBNZ has underestimated the level of the neutral OCR significantly then there is a risk the RBNZ over-eases in 2025, potentially setting up the next tightening cycle in 2026.”