Big 0.5% rate cut ‘no done deal’ as nerves jingle over inflation outlook

Wednesday, 15 January 2025

It doesn’t get any easier for home-owners trying to work out when and for how long to fix their mortgages.

ANALYSIS: BNZ has been warning the Reserve Bank could backtrack from the strong signal it sent in November that it anticipated cutting the official cash rate by a further 0.5% at its next meeting on February 18.

If it did, that would be a big disappointment for home-owners banking on further, faster mortgage-rate relief.

Reserve Bank governor Adrian Orr said when cutting the OCR to 4.25% in November that its future forecasts were consistent with another 50bp cut in February though “conditional on economic projections panning out”.

ANZ senior economist Miles Workman says it was a “firmer than normal” signal of its future intent.

It should be noted the guidance might be seen in the context of Orr perhaps trying to correct disappointment from some market traders who were expecting a more dovish statement on the day in November.

Under-steer and over-steer from the Reserve Bank aside, BNZ senior economist Doug Steel argues there is a lot of water to go under the bridge before the anticipated 50 basis point cut and it’s “no done deal”.

Workman says the market is currently pricing-in something very close to a 50bp cut — which simply implies traders see a roughly equal chance of a surprise either side.

Adrian Orr explains the decision to lower the official cash rate by 50 basis points to 4.25%. He discusses easing inflation and a subdued economy, but with a recovery expected by 2025. The Bank remains prepared to respond to future shocks.

But Steel thinks there is “much more chance” of a 0.25% cut than a 0.75% one, which would suggest some risk of a rise in fixed interest rates next month — not what many home-owners will probably have been expecting.

BNZ’s concerns are straightforward.

Much of the recent economic data in New Zealand may have been weak, including the big drop in GDP reported by Stats NZ in December and some fairly downbeat surveys of current business activity.

But the drop in the value of the New Zealand dollar and a rise in oil prices could propel imported inflation higher than the central bank had been counting on.

Indeed, BNZ is expecting Stats NZ will report quarterly inflation in the three months to the end of March at 0.9%.

That would be the highest quarterly rate in 18 months and push the annual inflation rate back up from 2.2% to 2.5%, which is where BNZ expects it to stay for nine months.

“The Reserve Bank has said it will look through short term shocks which is entirely appropriate, but such movements will be disconcerting nonetheless,” Steel says.

Not all economists are getting quite as spooked.

Westpac chief economist Kelly Eckhold is still pretty confident of a 50bp rate cut given the Reserve Bank’s “fairly strong signal” and the few signs there have been of an imminent economic recovery.

The lower exchange rate is inflationary but the Reserve Bank tends to ignore that unless it threatens to have an impact on inflation expectations, while oil can bob about, he notes.

But imported inflation could have an impact on the interest-rate outlook beyond next month’s monetary policy statement, Eckhold says.

“The Reserve Bank has taken a fairly strong view that something close to 3% is a ‘neutral OCR’ rate. I think it's probably higher than that.”

Workman says it is the rate the OCR ultimately drops to, rather than the journey it takes getting there that is most important to borrowers and lenders.

ANZ is relatively hawkish in having 3.5% as the plateau for the official cash rate “which is an acknowledgement that inflation pressures could prove a bit sticky”.

The Reserve Bank can control inflation expectations by talking tough on inflation and then following through with that in setting the OCR, he says.

“But where there are pockets in the economy where there is potentially structurally higher inflation, is in things like council rates with infrastructure deficits, insurance with climate change, and private health care with an ageing population.

“You can easily come up with a story that inflation is going to run a bit higher than otherwise perhaps over the next decade or two, than it did over the past decade, and for monetary policy that means a higher-than-otherwise OCR.”

CORRECTION: An earlier version of this story incorrectly reported that BNZ forecasts Stats NZ to next week report 0.9% quarterly inflation in the three months to end of December. Its forecast is 0.6% for that quarter and 0.9% the following quarter (amended 4.46pm, January 15, 2025).