🏦🇳🇿ANZ Preview on RBNZ November Meeting

• It’s certainly interesting times for the New Zealand economy. The labour market is the tightest it’s ever been and inflation pressures are intense, but on the other hand the housing market cycle is looking very mature, and there’s the small matter of COVID spreading its way around the country. On balance, the case for tighter monetary conditions is clear. It was already clear months ago, and the August MPS laid out an OCR forecast going just north of 2% by the end of the forecasts, with a first 25bp hike duly delivered on 6 October at the Monetary Policy Review, once the lockdown dust had settled. Since then, CPI inflation came in at 4.9% versus market expectations of 4.2% and the somewhat dated MPS forecast of 4.1%. The increase was broadbased, with non-tradable and core measures substantially beating expectations as well.

• We’re now forecasting a peak of around 6% in Q1, and the RBNZ will be revising up their CPI forecasts substantially too.  Consistent with that, 1-year-ahead business inflation expectations have jumped to 4.3%; household 1-year-ahead inflation expectations have jumped to 6.2%, and the RBNZ’s preferred measure of 2-year-ahead expectations out on Thursday is no doubt going to leap as well, the only question being how high. Firms’ reported costs and pricing intentions also remain extremely strong.

• The unemployment rate for Q3 came in at a record-low 3.4% despite record-high labour force participation. It was an absolute ripper, confirming incredibly strong labour demand and an exceptionally tight labour market. As COVID spreads, the labour force participation rate may drop – that’s been the international experience. And while it will soon be easier to import labour, we may lose more workers to Australia as well. In short, the RBNZ won’t be able to forecast with any confidence that labour market tightness is set to ease any time soon. Their wage growth forecast is likely to be revised up substantially. 

• ANZBO business activity and sentiment indicators have eased, but the levels are still very respectable. Hiring intentions are particularly robust.  Supply-side disruptions and cost escalation continue to plague a range of industries, with construction most severely affected, though there are tentative signs of reaching some kind of peak. 

• The housing market has turned, albeit only slowly. Seasonally adjusted sales are well off their peak, but annual house inflation only just so. The RBNZ continues to consult on debt-to-income restrictions to further rein in higher-risk lending.

• Swap rates have soared as markets have reassessed where the OCR is likely to sit over coming months and years, and mortgage rates have naturally followed suit. Indeed, we’ve seen the fastest increase in mortgage rates in at least 15 years (figure 2). A lot more effective tightening has been delivered than just one standalone 25bp OCR hike. Given the risks of a harder landing in the housing market than it might aim for are real, it’s not clear that the RBNZ would necessarily want to engender another widespread round of mortgage rate hikes, as opposed to just locking in what’s there now

• Markets will clearly be impacted by the decision itself (ie 25bps or 50bps) given that they are going into the meeting with a bob each way. We think a 50bp hike would be much more disruptive and cause greater volatility, and further upward movement, with markets likely to conclude that we could see another 50-pointer this cycle. We’re not convinced that a 50bp hike would see the NZD sustain any knee-jerk reaction higher, however, especially if commentators start to ponder whether such dramatic action might shock the economy. Markets are already pricing in an expectation that the OCR reaches around 2.5% in a year’s time, but that hasn’t helped the Kiwi of late, thanks partly due to growing expectations that policy will be normalised elsewhere.

• If the RBNZ delivers 25bp as we expect, the short end (like 1 to 3-month bills and the November OIS contract) will correct lower. But there is also some scope for 1 to 2-year swap rates to adjust lower (or at a minimum, not go higher). How they react depends less on the 25/50bp decision, and more on the RBNZ’s OCR track, which as noted, could have an end-point near 3%. But even if it did, from a valuation perspective there wouldn’t really be much justification for higher 1 to 2-year swap rates. If, for example, the RBNZ hikes by 25bps at every meeting until it gets to 3%, that’d see the OCR average around 1.41% and 2.12% over the next one and two years respectively. Add in your assumed Bills/OIS spread and that makes current 1 and 2-year swap rates look fully priced. Positioning might put sand in the gears of any correction, as might overall market nervousness. But the maths suggests that markets are going into this decision fully priced – and nervous.