Expectations for inflation and big OCR cut in full flight

The RBNZ expectations survey is a mixed bag on the 12-month and a two-year time frame for the fourth quarter of this year.

The survey shows inflation expectations increased slightly to 2.12% in the fourth quarter from 2.03% in the third quarter, but still within the Reserve Bank’s 1-3% target. 

On the one year expectation, it dropped to 2.05% from 2.40% in the third quarter of this year.

Expectations by businesses about housing are for prices over the next year to rise 0. 71% to just over 3%, but over two-years expectations fell nearly a 0.25% to 4.17%.

For the unemployment rate, expectations were up just one basis point from last quarter’s 5.11% to 5.22% in a year’s time, while for annual wage growth expectations declined slightly to 2.81 percent growth in a year's time, but the average two-year-ahead expectation rose 0.30% to 3.16%.

A drop in unemployment had led to expectations of a 0.75% OCR cut at the end of the month, but it didn’t soften as much as the RBNZ expected and provide a smoking gun for the RBNZ to ramp up monetary policy easing. 

Bank economists are all predicting a 0.50% cut and a more cautious RBNZ monetary policy environment next year as the implications of Donald Trump’s election as United States president and his promise to impose tariffs on all goods imported into country become clearer.  

They have pulled back from a 0.75% OCR cut this month.

Legitimate case for bigger cut

However, one fund is still pushing for the higher cut saying the economy is in dire straits.

Devon Funds investment manager Greg Smith is sticking to his guns. He says as inflation has fallen to within the bank’s target 1-3% band at pace, and given the current downturn, it could undershoot the 2% midpoint and go right to the bottom of the band at 1%. 

Smith says it is not hard to argue that “we should be at, or below, the RBNZ’s ‘neutral’ rate of 3.8%”, which neither boosts nor restricts growth right now. “The case for a 75-basis point reduction in the OCR does indeed seem legitimate.

“Interestingly a number of commenters who suggested only a few weeks ago that a 0.75% rate cut would be extreme, have now said that such a move is plausible.”

He says the risk of undershooting inflation on the downside is particularly possible in economies such as New Zealand’s which are facing numerous challenges and are effectively deflating. 

“Our economic data is dire, and the RBNZ should probably be pushing the panic button. The economy is in recession, and unemployment is on the rise. Various measures of confidence may be picking up, but from depressed levels, and are on the back of rate cuts which take time to filter through the economy.”

Some good news says Smith is that a larger rate cut now will take less time to filter through to the economy than it did previously.

RBNZ assistant governor Karen Silk said in a recent speech about 75% of new home loan flows currently carry interest periods of one year or less, and about 70% of existing home loans will be repriced within the next nine months.

Smith also says in addition to large companies, Devon Funds meets and talks with a lot of smaller businesses, and it is clear many are struggling, and some are even on the brink of failure. “A larger rate cut this side of Christmas might make all the difference.”

He says another imperative for the RBNZ to consider is officials do not have their next meeting until February 19 next year. “That’s nearly three months during which quite a lot can happen to the economy’s growth profile and not necessarily in a good way.

“There are those that contend a large rate cut is not warranted, considering the US Federal Reserve has stepped down from the jumbo 0.50% rate cut to a 0.25% reduction at its latest meeting this week. However, there are some additional points of relevance to note. The US economy is growing at 3% while New Zealand’s is contracting, and the Fed also holds meetings in December and January.”