Overheating The New Zealand economy has moved on rapidly from impressive resilience to outright frothiness. Since the May Monetary Policy Statement, the general flow of data has yet again been more positive than expected. Q1 GDP kicked things off, rising 1.6% in one quarter whereas the RBNZ had been expecting a fall of -0.6%. Since then:
Surveyed business activity and sentiment indicators are bouncing around the highest levels since 2017.
Measures of inflation pressure have continued to soar. Reported costs are through the roof and pricing intentions continue to break new ground, with a net 61% of firms (75% of retailers) reporting they intend to raise their prices in the next three months.
Inflation expectations are now approaching the top of the RBNZ’s CPI target band, and still rising.
CPI inflation is now 3.3%, and we are forecasting it to easily clear 4%. It’s not all temporary cost drivers – the broad-based inflation pressure was evident from the fact that the 30% trimmed mean was 3.0% (versus 1.6% in Australia). The RBNZ’s slow-moving sectoral factor model of inflation is also now above the target midpoint and rising.
The housing market has so far been pretty resilient to the tax policy change recently announced. Household house price expectations rose in the last consumer confidence survey.
The unemployment rate dropped to 4.0% in Q2, a level the RBNZ didn’t expect to see over its entire forecast horizon. Both employment intentions and job ads are extremely strong. Labour costs increased 0.9% q/q, a sharp pick-up in what’s usually a very slow-moving series.
Residential building consents are the highest in decades.
Shipping costs and delays continue to get worse, putting upward price pressure on all imported goods.
Firstly, inflation. A negative shock might well deal a body blow to inflation. But it might not, and that might hamper the RBNZ’s ability to ease if trouble strikes. Why might it not? If inflation is entrenched, it might prove hard to budge. The border is only going to inch open, meaning labour supply will remain artificially constrained for a long time yet. That ups the ante on the risk of a potential wage-price spiral. Figure 1 shows that the labour market is the tightest it’s been since at least the mid-1990s, and other indicators are also flashing red.
A second good reason to get on with hikes despite downside risks is avoiding unnecessary volatility in output, interest rates and the exchange rate. Apart from providing a nominal anchor, inflation targeting is meant to smooth the business cycle. That is, give demand a boost in the bad times but also take the edge off the exuberance in the good times, so that we don’t wildly oscillate between these states. Right now, an OCR of 0.25% is persuading people to take on a lot of debt. Even if that has no negative repercussions from a financial stability point of view, the fact is, the 0.25% is currently exacerbating the business cycle – making the current boom bigger, but thereby making the inevitable next slowdown tougher than it needs to be. In terms of interest rate and exchange rate volatility, the lesson of the 1990s and 2000s cycles was that “a stitch in time saves nine” – that kicking off a hiking cycle too late can lead to a perception that dramatic action is going to be required to rein things in. That can result in the yield curve steepening and the exchange rate rising more than necessary. Of course, with household debt so high and relatively lightly fixed, we don’t doubt the RBNZ can get traction on household cashflow quite quickly with rate hikes, but that doesn’t mean hiking too late is riskless. Aggressive policy action is more likely to result in a hard landing for the housing market, and if you want to avoid that, then you’d best get on with the job.
0, 25 or 50?
This is a challenging meeting for financial markets, insofar as 0, 25 or 50bps are all possible outcomes, and could be justified without a blush. We’d put 10% odds on no hike, 65% on 25bps, and 25% on 50bps.
In terms of why we think they will hike: the last Review was entitled “Monetary stimulus reduced”, signalling a clear start to a tightening cycle, and the data has been one-way since then. As regards 50bp, we’d certainly never say never. There are precedents for this committee along the lines of “just do it.” But this is the first hike of the cycle, in a highly uncertain environment where the world could change any second and flexibility is therefore valuable. The RBNZ is also going it alone and will therefore have a wary eye on the exchange rate, and finally, the October meeting is only six weeks away. But all the reasons we gave above for needing to get on with raising the OCR are also reasons to move fast. So the market is correct in our view to put some odds on an outsized move.
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