New Zealanders cooled their jets, so the Reserve Bank cut

Thursday, 15 August 2024

ANALYSIS | The Reserve Bank’s decision to take the dive and start cutting interest rates reflects a weaker-than-expected economy in the middle of a recession; a global economic slow down and government spending cuts that now may be flowing through to the economy, putting downward pressure on prices.

It has started to move the Official Cash Rate (OCR) down for the first time since March 2020. However, the first “low risk” cut comes with a big proviso ‒ the bank is waiting to see what how the domestic economy reacts before committing to too much too soon.

Governor Adrian Orr also hit back at critics who suggested the bank got it wrong in May when it was considerably more hawkish, saying that its view was always conditional on economic activity and events.

In November, he told New Zealanders they would have to “cool their jets”. Nine months later, the jets are cold.

“Consumer spending, I would say, is down considerably. You think it's down in aggregate, but then you divide it per capita, it's down significantly,” Orr said.

“To have such strong growth and migration ‒ and to have declining consumption ‒ is doing it tough. That's a cold jet.”

Orr also said the bank expected consumer response to the Government’s recent modest tax cuts and transfers was “going to be reasonably subdued given the broader economic context”. Translation: people probably won’t spend much of their tax cuts.

Prime Minister Christopher Luxon and Finance Minister Nicola Willis hastily called a press conference. Its purpose was to claim that the first bit of their economic plan was working and that interest rates were starting to come down as result, taking the risk of tying themselves to downwards interest rate movements as an indicator of good economic management.

“Today, I am pleased to say that we are seeing some encouraging, albeit early signs of progress, that our government's economic plan is working,” Luxon said.

“But our plan also refocused the Reserve Bank on a single mandate of price stability. In fact, it was the very first piece of legislation passed by our new government,” he said referring to stripping a commitment to full employment out of the Reserve bank’s mandate.

The central bankers will blanch at the idea that the Government changing the bank’s mandate had anything to do with this rate cut, while Luxon and Willis will bristle at any suggestion government spending restraint had nothing to do with it.

Orr cut an ebullient figure at the post-decision press conference, saying it was “so pleasing to be able to make that statement on behalf of the committee” and delivering on the news and talking about it was “bordering on emotional words”.

When asked to respond to a claim that Luxon made on X (formerly Twitter) that the Government had “delivered lower inflation”, Orr said he would stay out of the PM’s lane but did note: “I would kind of cheekily say success will always have 1000 fathers.”

“So I don't mind who wants to put their name in succeeding to low and stable inflation, as long as we get that,” Orr said.

But the rate cut and satisfaction came with a caution: monetary policy is still restrictive ‒ just less so than it was. And at 5.25% the bank is still a long way off what it considers its “neutral” cash rate of around 3%. More cuts are likely this year.

In late 2022, Orr agreed the Reserve Bank was “deliberately engineering a recession” in order to get inflation under control. In late 2023, under Grant Robertson, the Government starting paring back spending plans, which then became far more enthusiastic spending reduction once Willis took the Treasury benches.

“The darkest period is actually where we are right now,” Orr said of the current economic environment.

The Reserve Bank noticed and said in a record of the meeting that “alongside restrictive monetary policy, an earlier or larger impact of tighter fiscal policy could be constraining domestic demand.” In other words, the Government’s fiscal tightening could well be having an effect.

“Some of the reduction from the Government spending side has already occurred, but there is still more ongoing,” Orr said, lending some heft to the Luxon and Willis’ claims.

Willis said that “discipline continues” in the spending restraint that has seen staff and lower priority functions cut of the public sector ‒ further reducing pressure on inflation from government spending.

The headline OCR has been cut from 5.50% to 5.25% and the bank’s current projections now think the rate will come down to under 4% by the end of 2025. This is more than a 1 point drop on the same rate expected in May and is reflective of a deteriorating economic circumstances.

The bank forecasts a recession for the rest of year before tipping back into positive growth territory in 2025.

For the Reserve Bank, this was clearly a day of relief with a small amount of victory. After copping it hard for more than two years it now gets to start loosening monetary policy ahead of The Federal Reserve and the Reserve Bank of Australia. The latter in particular doesn’t look like it will move to cut any time soon.

For the Government, this earlier than expected rate relief plays perfectly into its broader economic narrative. A big part of being in Government is claiming success when positive things happen and blaming other factors when negative things occur.

But as many politicians have shown over the years ‒ from Grant Robertson to former Australian Prime Minister John Howard ‒ interest rates can always go up, despite all the good looking forecasts in the world and even with budget surpluses.

And the inverse side of a sooner-than-expected rate cut is a sicker-than-expected economy. That mean higher unemployment, fewer jobs, lower profits and less overall opportunity for New Zealanders.