Will the official cash rate remain on hold?

It's a projection, not a promise says RBNZ chief economist

Will the official cash rate remain on hold?

The Reserve Bank has indicated that the official cash rate has now peaked in the current cycle, however this is a projection, not a promise, says RBNZ chief economist Paul Conway.

The wholesale cash rate has increased by 525 basis points in just over 18 months, from a record low 0.25% to the current level of 5.5%.

Conway (pictured above) explained to NZ Adviser that the Reserve Bank publishes a projection for what it thinks will happen to the official cash rate over a three-year period.

According to projections released by the Reserve Bank as part of its May 2023 Monetary Policy Statement, the official cash rate will remain at the current level (5.5%) through to mid-2024, with rate cuts from the third quarter of next year.

Announcing the 0.25% rise in the official cash rate in May, the Reserve Bank said in its Monetary Policy Statement that the Committee was confident that with interest rates remaining at a “restrictive level” for some time, inflation would return to its 1% to 3% target range.

Conway said that projections were developed in line with what the Reserve Bank currently knew about the economy based on its starting point, and how it saw the global economy unfolding over the coming months and years. 

“What we’re saying now is that the Monetary Policy Committee is confident that will be sufficient to bring inflation back to our target,” he said.

Conway clarified that this was “not a promise” and said that the Reserve Bank reserved the right to change its projections.

ANZ is one the banks expecting one further interest rate hike this year, currently forecast for November.

“What we’re saying is that the future path of the official cash rate (if it stays on hold) or if we feel the need to increase it or if the next move is downwards, will essentially depend on how the economy unfolds,” Conway said.

Given that this is a time of uncertainty, Conway said that it was easy to imagine different scenarios in which each of those future moves in the official cash rate could be “very much on the table”.

There are some good signs that the economy is at a turning point, he said. Headline inflation is starting to moderate, and demand in the economy is starting to cool, as required by the Reserve Bank to bring inflation down.

Up until now, the key question had been how much the rate hike should be, he said.

“When you get towards a turning point, it becomes a little more nuanced and its quite normal that people can have different views on how that is going to play out going forward.”

Recession within the Reserve Bank’s forecast

While the Reserve Bank is forecasting a technical recession in the June and September quarters (with GDP projections of -0.2% and -0.1% respectively), Treasury projections do not.

Conway noted that the two sets of projections were essentially pointing to zero growth, indicating a “pretty sluggish economy” over the next few quarters.

He acknowledged that talk of a recession tended to invoke reactions but said that he expected it to feel like a slowing economy. New Zealand has had a migration surge over the last couple of quarters and migration remained reasonably high, he said.

“When you divide GDP or consumption (people spending on stuff) by the number of people in the country, it’s going to feel like a bit of a grind over the coming quarters as demand slows down to the supply capacity of the economy, and inflation continues to fall away from its peak,” Conway said.

Household balance sheets in “good shape” overall

Conway said that the Reserve Bank considered household balance sheets in detail as part of its interest rate setting process. In aggregate, household balance sheets are still in “pretty good shape” and the strong labour market is part of that, he said. 

“One of the reasons that the household sector is in good shape is that banks have been stress testing mortgages at higher interest rates than where they actually are,” Conway said. “We’re not seeing mortgagee sales and bank balance sheets are in good shape.”

He acknowledged that people who had purchased property at the peak of the cycle (November 2021) and had taken on a high level of borrowing would be under increased financial pressure.

“We fully acknowledge that the pressures are coming on for some people, but overall and from a financial stability perspective, there’s no reasons in aggregate why monetary policy can’t do what its being tasked to do, which is to control inflation and support maximum sustainable employment,” Conway said.

Aside from influencing the credit channel, Conway said that monetary policy also influenced other areas of the economy, such as the exchange rate. Where real interest rates are positive, monetary policy encourages people to save and borrow less. It also affects the housing market, which through time, influences rents, he said.