RBNZ Review: Protecting Their Hawkishness for Now

Summary

• The Reserve Bank of New Zealand (RBNZ) hiked the Overnight Cash Rate (OCR) by 50bp to 4.75%, as we expected.
• Going forward, we are watching for signs that core inflation is turning and near-term inflation expectations are moderating. Additionally, they will keep an eye on the ‘MSE Indicator Suite’ and four new labour market indicators.
• Meanwhile, Cyclone Gabrielle provides the RBNZ with new uncertainties. They added a ‘raw’ 0.3pp to their inflation forecast for the March and June quarters as a result. In the near-term, they will look through spikes in inflation and drops in activity while it will prove pertinent to track North Island wages and prices.
• Markets are pricing 35bp for the April meeting, 20bp for May, and a 5.45% terminal rate. We believe the RBNZ terminal rate is at 5.25%, though risks are skewed to the upside.

Market Implications

• We continue to see value in short NZD/USD and receiving NZD 2Y OIS rates with the latter now at cycle highs.

RBNZ Protect Hawkish Optionality

The RBNZ hiked the OCR by 50bp to 4.75%, as we expected. We thought they may continue to protect their hawkishness, providing risk to our bearish NZD and bullish NZD 2Y OIS trades. However, we did not expect them to retain a projected 5.5% peak in the terminal OCR. Going forward, they will have a close eye on core CPI and near-term inflation expectations, as well as their ‘MSE Indicator Suite’ and four new labour market indicators. Funding for Cyclone Gabrielle will be well followed, too.

Pay Attention to Any Weakness in Core Inflation

‘Early’ Encouraging Signs for Inflation

The RBNZ were encouraged by the undershoot in inflation, especially in non-tradables. ‘Early’ (debate occurred on the specific word the RBNZ would use) signs have appeared that price pressures are easing. However, the RBNZ continue to (understandably) deem inflation to be too high. As it stands, they forecast a stubborn first quarter (Q1: +7.3% YoY; +1.8% QoQ) with headline CPI returning to target in Q3 2024 but non-tradable inflation staying decently above target (Charts 1 and 2).

Cyclone Gabrielle Estimated to Add 0.3pp to Q2 and Q3 Headline CPI

There are risks to the forecasts. Initial estimates (the RBNZ work on official statistics, of which there are few for Cyclone Gabrielle) pencil an additional 0.3pp on inflation in each of the March and June 2023 quarters. This is a ‘raw’ estimate. In the near-term, they expect car prices, food, accommodation and construction to be worst affected – they will look through this (a heavily noted point, both for inflation and activity). Beyond that, in the medium-term, they expect higher-than-otherwise construction work prices and the possibility of inflation expectations remaining high. This all remains highly uncertain.

Uncertainty Surrounds Non-Tradable Inflation

Inflation forecast uncertainty is broad. A ‘special topic’ was dedicated to ‘the international dimension of non-tradable inflation’ – correlation between non-tradables inflation and global inflation has steadily increased since the GFC (Chart 3). They believe there is insufficient statistical evidence to suggest the Kiwi economy has synced with other major business cycles. And while they find the purchase price of new housing, and domestic air travel and accommodation is now highly correlated between Australia and New Zealand, they believe correlations have failed to pick up consistently across the basket (Chart 4). To conclude, they believe uncertainty surrounds non-tradables inflation, which could equally add to, or takeaway, from the peak OCR.

RBNZ Want Near-Term Inflation Expectations to Retreat

Inflation expectations appear to have peaked, and in the case of the two- and five-year inflation expectations they have turned lower. However, the RBNZ decided to say they ‘remain elevated’. The RBNZ wants near-term (one- and two-year) business inflation expectations to retreat (Chart 5).

RBNZ Expand Coverage to Track Labour Market

The labour market is showing its first cracks; unemployment and private sector wages were weaker than November forecasts, but the RBNZ wants to see more. They need the labour market to weaken to a level consistent with maximum sustainable employment (MSE) – only one of 16 has (Table 1). As it stands, the RBNZ expects unemployment to return to MSE by Q3 2023.

However, this is half the issue. The RBNZ are finding people changing jobs more often since the start of the Covid-19 pandemic with above-average pay rises being offered. Looking forward, while the official numbers (versus forecasts) will remain important, two other developments must be followed:

1. Wages on the North Island – the RBNZ do not want to see people ask for larger wages during the rebuild from the cyclone. We will track this using the Xero Small Business Indices as a proxy.
2. Four new indices the RBNZ have developed – more on this below.

The second ‘special topic’ was dedicated to ‘monitoring the labour market for inflationary pressures with high-frequency microdata’. Kiwi labour market data is not great – quarterly and without the same level of depth as other developed nations’ statistical departments deliver. As a result, the RBNZ has turned to high-frequency microdata that tracks job changes and wage adjustments. As it stands, these newer measures suggest that wage inflation will remain high over the coming months (Charts 6 to 11). The data is non-public (by application only), so we will keep an eye out for mentions in correspondence.

What Impact Will Cyclone Gabrielle Have?

Ignore Short-Term Changes in Activity

Survey data suggests an already weak economy (Table 2). Now, North Island consumption is likely to peter, at least in the near-term. Goods exports, including fruit, vegetables, logs, meat and dairy, will decrease. The RBNZ are aiming to look through these near-term fluctuations. Instead, they will focus on medium-term trends in data. Further afield, the RBNZ expects to see increased private construction and investment.

Summary

The RBNZ have held their hawkish nerve, in part due to uncertainty, but also to ensure inflation expectations and core inflation turns lower. Going forward, the RBNZ will want to see progress in core inflation and near-term inflation expectations. Additionally, they will keep an eye on their ‘MSE Indicator Suite’ and four new labour market indicators. Cyclone Gabrielle adds to the RBNZ’s uncertainties. We continue to see value in short NZD/USD and receiving NZD 2Y OIS rates with the latter now at cycle highs.

Ben Ford is a Researcher at Macro Hive. Benjamin studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively. 

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)