OCR unchanged at 5.5% but rate cuts may be further away than expected

Wednesday, 22 May 2024

The Reserve Bank has kept the official cash rate unchanged at 5.5%, as economists had forecast, but there is a sting in the tail for borrowers.

The bank had indicated in February that rate cuts were likely to arrive some time during the first half of next year.

But its latest forecasts suggest it may not start easing monetary policy before November next year.

Its forecast would also suggest there is still some chance of a further rate hike, to 5.75%, by the year’s end.

A gloomier outlook for inflation underpinned the more hawkish outlook.

The bank had previously been forecasting annual inflation would drop below 3% in September and finish the year at 2.5%.

But it is now forecasting inflation will only have fallen to 2.9% by December.

At the same time, its forecasts for unemployment have not improved, with the bank still tipping the official unemployment rate to peak at 5.1% next year.

If the bank’s forecasts are correct, the economy has now moved out of recession but will grow by only about 1% this year.

Reserve Bank governor Adrian Orr said higher rents, insurance costs, council rates, and other domestic services price-inflation meant domestic inflation was only declining slowly, posing a risk to inflation expectations.

The bank’s monetary policy committee said central banks overseas were also delaying rate cuts.

“The committee agreed that interest rates need to remain at a restrictive level for a sustained period to ensure annual headline inflation returns to the 1% to 3% target range.”

Financial markets immediately responded to the statement by sending the New Zealand dollar higher.

It was trading up about half of a US cent at US61.5c shortly after the announcement.

ASB chief economist Nick Tuffley was quick to label the monetary policy statement as hawkish, compared to expectations.

“There was considerably more concern noted about the strength of service sector inflation,” he said.

The bank’s forecasts suggested the OCR would not be cut until around August next year “at the earliest”, about three months later than implied by the Reserve Bank’s February forecasts, he said.

The Reserve Bank’s forecasts did not incorporate any implications of fiscal policies expected to be announced in next week’s Budget.

But its monetary policy committee “discussed the implications of the publicly announced aspects of Budget 2024 for the economic outlook”.

“If the decline in government revenue due to tax cuts is fully offset by lower government expenditure, then the net impact on aggregate spending is broadly neutral over an extended horizon,” it said.

“The committee noted that the signalled lower government spending is currently and expected to continue contributing to weaker aggregate demand.”

But it said likely changes to government spending or private spending due to proposed tax cuts “are not in the May monetary policy statement projections”.

“This timing difference poses an upside risk to the forecast of aggregate demand, the relevance of which for monetary policy will be clearer over coming quarters,” it warned.

Some analysts are continuing to forecast the official cash rate will start falling towards the end of this year, much sooner than the Reserve Bank is expecting.

Capital Economics economist Abhijit Surya was in that camp, describing the Reserve Bank’s suggestion that it might not start cutting the OCR until “the final quarter of next year” as a calculated bluff.

“In our view, the bank is overestimating the upside risks to the inflation outlook.

“If we’re right that inflation will in fact return to target by the third quarter, the bank should have no qualms about easing policy by the fourth quarter of this year,” Surya said.

Orr made clear he had no desire to respond to the claim the central bank was bluffing and said he was not concerned by the difference in expectations.

“We are the ones who are responsible for delivering low and stable inflation. The good news is we get to do it every six weeks and continue to learn as we move, just as many of the commentators have,” he said.

The bank’s tough words do appear to have shifted the thinking of some economists.

Infometrics chief forecaster Gareth Kiernan said the “extended wait” the Reserve Bank was forecasting before cutting interest rates was far too long, but he said Infometrics was likely to shelve its current forecast that there would be a rate cut in November.