What the inflation rate means for the official cash rate

Wednesday, 16 October 2024

The CPI and OCR - they’re a jumble of letters that can both greatly affect our wallets and how the next year will go when it comes to the cost of living.

The CPI, or consumers price index, increased 2.2% in the September 2024 quarter compared to the same time last year, bringing annual inflation within the Reserve Bank of New Zealand’s target band of 1 to 3% for the first time since 2021.

The OCR, or official cash rate, also dropped by 50 basis points to 4.75% last week, and mortgage rates dropped almost instantly. Another review of the OCR is coming up in late November.

So now that it seems inflation is finally under control after a rough couple of years, what will it mean for the OCR and interest rates?

Infometrics chief forecaster Gareth Kiernan said the CPI’s 2.2% per annum result was slightly better than the 2.3%pa the Reserve Bank was forecasting in August.

“With inflation close to the midpoint of the Reserve Bank’s target band, we expect the Reserve Bank to continue its monetary policy easing next month with another 50-point cut to the official cash rate.

“Further weakness in other data over the next few weeks could reinforce the need for a bigger cut to get interest rates back towards neutral faster, so a 75-point cut remains a strong possibility.”

This would in turn bring interest rates down - but had we suffered too long with excruciatingly high interest rates? Kiernan believed so.

“The Reserve Bank had been forecasting since early this year that inflation would be back within its target band by the end of 2024, and if the Bank was confident in its forecasts, it would have been appropriate to start gradually cutting interest rates sooner.

“The speed of the moderation in inflation has been faster than had been forecast, so the Bank needs to be cut some slack for that – it was understandable at the start of the year that the Bank wanted to be sure inflation would come back under control, given domestic price pressures still looked problematic, and that the Bank would regain its inflation-fighting credibility.

However, inflation was now virtually back at the mid-point of the Reserve Bank’s target, yet the Bank has only just started cutting interest rates, he said.

“Those interest rate cuts will only have an effect on real economic activity in 6-9 months’ time minimum, meaning that the Bank’s actions now will only start to stimulate things about mid-2025.

“In essence, the Bank was slow to react when inflation was accelerating, and therefore needed to raise interest rates faster and further later in the cycle, and it now looks like the Bank is repeating the error on the way down.”

Westpac senior economist Satish Ranchhod said inflation looked set to track close to 2% over the year ahead.

“Consistent with that more-contained inflation outlook, we expect that the RBNZ will deliver another jumbo-sized 50bp cut in November, with further but more gradual cuts next year,” he said.

But although the RBNZ would now be feeling more comfortable about how inflation is tracking, there were still key areas to watch that could be important for the stance of monetary policy, including domestic inflation and council rates, he said.

ASB senior economist Mark Smith said it expected CPI inflation to hover around 2% in future, potentially falling below 2% by early 2025 and expected a 50bp OCR cut in November followed by a sequence of 25bp cuts and a 3.25% OCR endpoint.

But Smith said the RBNZ proved to be too slow.

“The largest regret now is that the RBNZ proves to be too slow in monetary policy easing, contributing to economic scarring and sizeable job losses.”

Kiwibank chief economist Jarrod Kerr said the rapid rise in interest rates had inflicted pain on businesses and households.

“We’ve been in recession for two long years. And with inflation now back in its box, we can expect to see more rate cuts,” he said

He said interest rate relief was “needed and called for” and expected to see another 50bp rate cut come November.

“That will take the cash rate down to 4.25%. A fair fall from the 5.5% painful peak. From there, we think the RBNZ will cut towards 3%, a far more neutral rate. And they may need to chop below 3% to 2.5%, if the economy struggles to fully recover,” he said.