Immigration surge threatens smooth path to lower interest rates

Thursday, 30 November 2023

Fresh forecasts from the Reserve Bank suggest there may be one more hike in the official cash rate next year, but many economists do not appear to believe it will come to that.

The bank kept the official cash rate (OCR) on hold at 5.5% when it released its final monetary policy statement for the year on Wednesday. It is not scheduled to review the key interest rate again until February 28.

But the bank tweaked its estimate of where it expected the OCR would ideally sit between June and September next year from 5.6% to 5.7%.

Since the bank only tends to move the OCR in 0.25% increments and will issue two further forecasts before then, the new interest rate track would appear to slightly change the odds of a further hike to 5.75%.

The Reserve Bank indicated nervousness over record immigration was a factor behind the more hawkish tone of its latest monetary policy statement.

Stats NZ’s initial estimate was that net immigration rose to a record high of 118,800 in the year to the September.

The Reserve Bank has frequently noted immigration has mixed implications for inflation given it drives up demand in the economy, including for housing, while potentially dampening wage rises.

But it more strongly highlighted the inflationary risks in its Wednesday statement.

Reserve Bank governor Adrian Orr said it had observed that, globally, countries that were experiencing high net inward migration were also experiencing higher inflation, mainly due to the impact on rents.

Chief economist Paul Conway also noted house prices had lifted 2.4% from the trough created by their earlier 15% decline.

While the bank expected house price rises would be “relatively subdued” over the next three years, population growth was putting upward pressure on them, he said.

Orr said the bank’s monetary policy committee remained wary of ongoing inflationary pressures.

“Let me be clear, inflation is declining. Where we are nervous is ‘is it declining fast enough for us to succeed in the lowest-cost fashion.

“When we start from a very elevated level of consumer price inflation, we have limited headroom to absorb additional inflation surprises.”

Capital Economics economist Marcel Thieliant said that while the Reserve Bank had signalled that it could hike rates further, it still believed the tightening cycle was now over and that the bank’s next move would be a rate cut in the second half of next year.

Moody’s Analytics said it remained cautiously optimistic that the labour market and inflation would cool “allowing 5.5% to be the terminal policy rate”.

ASB chief economist Nick Tuffley also expected the OCR would not go higher, saying there still appeared to be a high hurdle for any further increases.

But ANZ chief economist Sharon Zollner said it saw the risks around the OCR as “two-sided from here”.

“Data on the labour market and inflation expectations will be particularly important to watch over the long summer break,” she said.

Orr has previously clashed testily with Nicola Willis, the new Finance Minister, in select committees over the bank’s handling of monetary policy during the period of Covid lockdowns.

Orr admitted last year the bank’s policies had been too stimulatory for too long.

But that appeared to be water under the bridge based on Orr description of his first meeting with Willis and Prime Minister Christopher Luxon in their new roles on Tuesday.

“The vibe in the room was incredibly constructive and highly focused on the job in hand, and the ‘number one’ job in hand for us is to reduce inflation,” Orr said.

The Government has promised to refocus the central bank’s mandate solely on inflation and to consider setting a specific time frame for the bank to achieve its target of bringing inflation back down under 3%.

Orr said that had not been discussed at the meeting on Tuesday.

“We have not been consulted on the remit change, but we're fully aware of the Government's stated intention to move from a dual mandate to a single mandate, so we we will be consulted in due course.”