More interest rate cuts needed – economist

Annual inflation remains within the Reserve Bank target band, but the optimal level has not yet been reached, a leading economist says.
Latest inflation figures released on Wednesday showed annual inflation remained unchanged at 2.2%, up 0.5% over the three months to December 2024.
Kiwibank economist Jarrod Kerr (pictured above) told NZ Adviser that while the bank considered the Reserve Bank’s job done, the magic inflation number was 2%, a level that he said wasn’t a hard target, but represented “a line in the sand”.
“It’s a global consensus among central banks that you want a bit of inflation; you don’t want too much, and you don’t want too little,” he said.
The bank had forecast annual inflation of 2.1%, a touch under the official figure, and Kerr said that he now expected the annual inflation rate to “bounce around 2%” – but noted it could go lower.
“We think that there is some downside risk, and that inflation may fall below 2% for a period: it might get as low as 1.8% if the tradeables [imported inflation, down 1.1% over the year] continues,” Kerr said.
“It does support our thesis that more rate cuts are needed and that there’s enough disinflation in the pipeline feeding through that the Reserve Bank can afford to stimulate a little bit.”
Kerr said that following a drop in the currency, a bounce-back in tradeables inflation could occur, making imported goods slightly more expensive. This may flow through to higher prices at the pump, he said.
Domestic (non-tradeables) inflation was slightly heated but was “heading in the right direction” and would likely fall to 3% over the next two quarters, he said.
What prices have potential to fall further?
Kiwibank noted that 251 items in the CPI basket (around 40%) recorded price drops – the highest number since COVID-19, with fewer recording price rises.
Commenting on the categories of goods that may encounter further falls, Kerr noted that services inflation (e.g. prices for trades, restaurant food) rose slightly over the last quarter and said a weakening of the labour market and weaker wage growth would likely feed through into softer services inflation this year.
“That’s the last shoe to drop … we saw a spike in goods up and then down, and the same will happen for services this year,” Kerr said.
Fixed mortgage rates unlikely to drop significantly
Kerr confirmed that financial market expectations did not change course following Wednesday’s inflation print.
“The market has got 50 basis points pretty much fully priced in for February, and another 25 basis points fully priced following that,” he said.
He said the key question lay around when the official cash rate, currently 4.25%, would fall from 3.5% to 3%, noting that wholesale interest rates currently had around 3.12% to 3.13% priced in.
“Market traders are of a similar view to us in that the Reserve Bank should and will cut to 3% this year,” he said.
But while an official cash rate of 3% was in the Reserve Bank forecast, Kerr noted there was a lack of consensus around the timing, the Reserve Bank indicating in its November forecast that it would cut the OCR to 3.5%, then wait.
Banks have steadily announced reductions in shorter term mortgage rates, ANZ the latest bank to announce decreases to standard and special fixed rate mortgage rates, bringing its 1-year special rate down to 5.57% and its 2-year special rate to 5.44%.
With 0.75% of further official cash rate cuts largely priced in, Kerr doesn’t expect fixed mortgage rates to fall significantly further between now and May. He noted that banks had moved ahead of Reserve Bank decisions and “pre-loaded” rate cuts.
“If the Reserve Bank do cut all the way to 3%, we’ll possibly get a little more movement later this year,” he said.
“We’re talking 10, 13, 20 basis points … most of the big move has been passed through already.”
Kerr noted that while the overall market sentiment was “cautiously optimistic”, this had not yet fed through to activity.
“Confidence has gone up which is great, activity has yet to respond and that’s where it starts turning into proper recovery,” he said.
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