RBNZ Review: 75bp Hike, Another to Follow in February 2023
- By Ben Ford
- 4 min read
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Summary
- The Reserve Bank of New Zealand (RBNZ) hiked the Official Cash Rate (OCR) by 75bp (to 4.25%), as we expected. The larger-than-usual hike came amid stronger core inflation and wage growth alongside increasing inflation expectations.
- The RBNZ are using December 2019 as their guide for maximum sustainable employment (MSE) – 16 of 17 indicators suggest the labour force is beyond MSE.
- Wages have grown faster than expected. This was driven by people being promoted or switching jobs for better pay. Meanwhile, some are working longer hours to compensate for inflationary pressures.
- Inflation is forecasted to decline significantly in H2 2023. However, domestic inflation is forecasted to persist and not to return to target within the forecast horizon.
- Elsewhere, house prices are expected to fall another 10% – a level the RBNZ believes is sustainable – retail lending rates are yet to reflect the wholesale interest rates, and tourism is booming.
- There is a question of whether the economy handles a 5.5% OCR.
- Looking forward, they forecast another 125bp of hikes to come with a terminal rate of 5.5%. We see a 75bp hike on 22 February 2023.
Market Implications
What to Watch?
The RBNZ hiked the OCR by 75bp (to 4.25%), in line with our expectations. They broke their streak of five straight 50bp hikes that constituted the majority of their 325bp of work thus far. While a sixth 50bp move was up for discussion, the question of 75bp or 100bp dominated the conversation.
Three points (core inflation, wage growth and inflation expectations) convinced the Board for the larger-than-usual move. Three additional points (above sustainable house prices, low lending retail lending rates, and booming tourism) added to the argument, too.
The Labour Force Remains Tighter than Expected
The labour force proved tighter than expected. Indeed, 16 of 17 indicators the RBNZ consider suggest that the labour force has continued to operate past MSE, benchmarking against December 2019 – they derived the best indicators back in June 2019 (Chart 1). They forecast unemployment to be back to these levels by Q3 2023.
Jumping Ship to Pick Up Bigger Pay Packets
Wages grew faster than the RBNZ had forecasted. Of the four key measures of wages and income – Quarterly Earnings Survey (QES) gross earnings per filled job, QES average hourly earnings, and the unadjusted and adjusted Labour Cost Index (LCI) – the two QES measures increased more than the LCI measures. In short, it means people are being promoted or switching jobs for better pay while some are working longer hours to compensate for inflationary pressures.
Looking forward, the RBNZ expects LCI wage growth to peak c.5.7% in late 2023. Meanwhile, the Bank sees public sector wage growth as an upside risk to wage growth.
Inflation to Decline Significantly in H2 2023
Inflation continues to pose an issue and a headache for the RBNZ. Every central bank has been caught short, including the RBNZ – the Bank of Canada wrote, back in July, on why they had been forecasting inflation poorly. Now, the RBNZ is forecasting a significant decline in H2 2023 driven by easing global pressures (Chart 2). Meanwhile, domestic inflationary pressures are yet to be forecasted to return to target.
As usual, there remain risks to the forecast. Two are already known: the announced reintroduction of fuel-related taxes in January 2023 and the expiry of transport subsidies. Both will provide one-off boosts to inflation in Q1 2023.
Labour Force, Inflation and Wages Not the Only Issue
The RBNZ noted three additional points as to why they hiked at a faster rate.
- House prices are above a sustainable level!
- The RBNZ see house prices as somewhat sustainable at 20% below the 2021 peak. Their forecasts sit just above this level meaning they are likely little worried about the effect of their hikes on house prices, at this juncture.
- Retail lending rates are yet to reflect wholesale interest rates
- Passthrough of cash rates matter most when affecting debt service ratios. However, mortgage rates – we proxy retail interest rates using the average floating rate offered by ANZ, Auckland Savings Banks, Bank of New Zealand, Kiwi Bank, and Westpac – have failed to keep up with the pace of OCR hikes (Chart 4). The OCR has risen 4pp in just over a year while mortgage rates have risen just 2.9pp.
- Tourism is booming
- Visitors have returned to New Zealand faster than expected. In particular, forward bookings are strong, especially by higher-spending travellers from the US, Canada and the UK.
OCR Forecasted to Reach 5.5%
The RBNZ is taking no chances, they forecast a 5.5% terminal OCR. A 1.5pp increase from the August MPS. However, it is questionable whether the economy will handle such a policy rate. The November Financial Stability Report found that another 10% fall in house prices (which the RBNZ have forecasted) would place 5-10% of current mortgage owners in negative equity (20% fall = 17.5% in negative equity; 30% fall = 37.5% negative equity) while 7% mortgage rates (we are above that for offered floating mortgage rates) would mean nearly half of 2021 mortgage borrowers would have a debt servicing ratio above 50%! Turning to businesses, primary industries are most likely to feel the pain first (Chart 6).
Expectations for Next Meeting
The RBNZ hiked to 4.25% (+75bp) amid stronger core inflation and wage growth alongside increasing inflation expectations. We expect another 75bp to follow in February 2023. We continue to think that RBNZ cuts (and BoC) are mispriced vs the Fed.