RBNZ Review: RBNZ Yet to Forecast Realistic Rate Cut Timeline

Summary

• The Reserve Bank of New Zealand (RBNZ) delivered a dovish 25bp hike to 5.5%.
• Inflation is forecast to return to target by Q3 2024, with non-tradables flirting with the top of the band from H1 2025.
• The RBNZ’s forecasted rate cuts are inconsistent with the likely path of inflation expectations and their labour market indicator suite. Meanwhile, mortgage refixes will force a sharper downturn than forecasts suggest.
• There is no material relationship between immigration and YoY changes in CPI.

Market Implications

• Markets are likely to reprice RBNZ cuts sooner – we believe the RBNZ have likely cut by February 2024. There remains value in finding entry to receive NZD 2Y OIS.

RBNZ’s Dovish Turn

The RBNZ delivered a dovish 25bp hike to 5.5% in what may prove their last hike of the cycle. With it, they laid out an even more dovish take on data than we had expected. We had expected them to lean on growth- and inflation-related factors and prove optimistic on the labour market (all of which they delivered), but they also took a (surprisingly dovish stance on immigration and the budget. We thought that they would force caution in the decision. It didn’t. And now the RBNZ hiking cycle appears potentially complete, with markets assigning just a 27.5% probably of another hike. We turn our focus to cuts, which the RBNZ have failed to provide a realistic timeline on.

RBNZ Forecast Fall Short on Realistic Rate Cut Timeline

Inflation to Return to Target by Q3 2024

At the last meeting, the RBNZ noted ‘early’ signs that price pressures were easing. However, the comfort was far from widespread. Going into this meeting, undoubtedly, dovishness had spread; Q1 inflation fell short of forecasts with food the only category to surprise positively (Chart 1). Non-tradables slippage has proven distinctly important, too. Meanwhile, inflation expectations returned towards normality (Chart 2).

Going forward, the RBNZ expects headline CPI to increase +1.1% QoQ through Q2 (18 July; Chart 3). More broadly, they expect inflation to return to target by Q3 2024 with non-tradables flirting with the top of the target band from H1 2025 (Chart 4).

Forecasted Rate Cuts Inconsistent with Likely Path of Inflation Expectations

RBNZ forecasts suggest inflation expectations will continue lower. Considering the spread of 2Y versus 1Y inflation expectations¹ we find that, historically, a collapsing spread has occurred just prior to an RBNZ cutting cycle (Chart 5). Using the historical relationship between YoY CPI and 1Y and 2Y inflation expectations, we find that the RBNZ are forecasting cuts too late (July 2024).

Labour Market Forecasts Suggest Q4 RBNZ Cut

The labour force was one reason we were comparatively dovish versus the market; the RBNZ’s broad set of labour market indicators peaked (Chart 6). Their goal has been for the labour market to return to maximum sustainable employment (MSE) by the third quarter of this year. When the labour market was previously this tight in a hiking cycle, the MSE indicator contracted 57% from its peak before the first RBNZ cut. Using the forecasted unemployment rate path^2,3 we find a similar weakening in the labour market is likely to have occurred by Q4 of this year, supported by our labour market indicator (Charts 7 and 8). This suggests a RBNZ cut is due at their November 2023 or February 2024 meeting.

Mortgage Refixes to Force Sharper Downturn than Forecasts Project

The economy unexpectedly contracted 0.6% in Q4 2022. And now, the RBNZ expect activity to remain subdued with contraction forecasted from Q3 2023 to Q1 2024. But there’s room for it to underperform even these pessimistic forecasts. That is because the RBNZ are unsure how a large number of households will experience rolling onto higher fixed rate mortgages.

As it stands, at least 37% of outstanding mortgages are set to refix by the end of January 2024, with 11% having refixed within the past three months (Chart 9). That’s 48% of outstanding mortgages. Another 29% will refix in the year that follows that, too. As mortgage rates catch up with RBNZ OCR hikes refixing mortgages will become costlier as the spread between offered above the current outstanding mortgage rates widens (Charts 10 and 11).

Large Immigration Influx Does Not Imply Inflation

There has been an influx of migration since international borders reopened, far outpacing initial RBNZ forecasts. Now, they expect the pace of immigration to ease back towards pre-Covid trend levels over the coming quarters (Chart 12). This may well happen. However, there is no concrete relationship between the annual change in inflation (headline or non-tradables) and yearly net immigration, even when lagging data (Chart 13).

Summary

The RBNZ delivered a dovish 25bp hike. Looking forward, there remains some risk of another hike, but the real interest lies in cuts. Here, the RBNZ are more hawkish than we are. We believe the RBNZ will have to cut at their November 2023 or February 2024 meeting.

[1] – Here we mean the difference between RBNZ business inflation expectations two years out minus one year out.

[2] – It is transformed by taking the z-score with an average calculated over Q4 2019 and a standard deviation calculated over Q1 2000 to Q4 2019.

[3] – Semi-realistic given the wider labour force MSE indicator has a 94% correlation with the z-score of unemployment taken as in [2].

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

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