New Zealand interest rates are still rising, but a slowdown in rate hikes is possible. Tina Teng explains why this could happen and the implication for the NZ stock markets and the Kiwi dollar | Partnership content
Opinion: Rate hikes have become the norm for central banks amid surging inflation, intensified by the war in Ukraine.
In August, the Reserve Bank of New Zealand raised the official cash rate by 50 basis points to 3%, the fourth straight 50 bps hike since April.
With the New Zealand inflation sitting at 7.3 percent in the second quarter, Reserve Bank’s rate hikes are likely to continue. Comments by governor Adrian Orr suggest that he sees sacrificing economic growth as the necessary price to be paid to fight sticky inflation: "There will be a prolonged period where economic demand has to be reduced to below the potential growth rate of the economy, to take the inflation pressures out,” he recently told interest.co.nz.
The Reserve Bank sets the official cash rate based on two economic indicators: headline inflation and unemployment. So, what does the data look like?
In June, the unemployment rate was at 3.3%, which is the lowest since 2007; while headline inflation soared to 7.3% in the second quarter, hitting a 32-year high. Clearly, the key gauges are far from convincing the Reserve Bank to pause its rate hike approach, which aims to curb inflation back to the target range of between 1-3%.
The cost-of-living crisis, driven by structural inflation and then intensified by war and supply chain disruptions, is the major issue that all the central banks continue to wrestle with.
Despite determination to fight inflation, a slowdown in the pace of rate increases is likely, in my view, given the deteriorating economic data, the drop in commodity prices and the risk posed by rising unemployment.
New Zealand’s economy is struggling due to rapidly rising rates, high inflation and a plunge in business and consumer confidence. After negative GDP growth in the first quarter, retail sales decreased 2.3% in the second quarter and the business confidence index is looking as sad as it did in 2008 when the Global Financial Crisis hit (except for briefly in March 2020 with the arrival of Covid).
A decline in value of the Kiwi dollar would lead to increased inflationary pressure on the price of imported goods, though a lower currency value would encourage exporters. But wage growth is spiralling up in the midst of a tight labour market, with a 3.4% increase in the yearly private sector labour cost index – also the highest since 2008, according to Stats NZ.
ANZ New Zealand Business Confidence index
On top of all of this, a plunge in the best New Zealand housing markets is dampening consumer confidence. July figures show house prices declined for the previous five months, or a 2.9 percent annual drop – the first drop for 11 years.
Shrinking household wealth is putting a brake on spending, and electronic card transactions declined 0.5% in July compared to the year before, pointing to the first period of negative growth since October 2021.
Aggressive rate hikes could trigger a recession
Aggressive rate hikes in a deteriorating economy run the risk of tipping it into recession – something the Reserve Bank will be wary of. On the other hand, softening consumer demand, a drop in the price of crude oil and other commodities will most likely lead to lower consumer prices in the coming months.
The Reserve Bank’s mean two-year inflation expectation for the third quarter lowered to 4.2% from 5.0% in August. The often-used rate hike monitoring tool, the New Zealand bond futures, now appear to be banking on a total 70 basis points rate hike at the next two policy meetings in October and November, which would bring the OCR to 4% at the end of the year, suggesting a slowdown in the pace of rate hikes.
Impacts for equity markets and the Kiwi dollar
In a scenario where the Reserve Bank starts scaling back rate hikes, the New Zealand equity markets may see it as tailwind and continue their rebound trend since mid-June. Most of the local blue-chip companies reported strong FY22 full year results and provided positive outlooks for the second half, The NZX 50 outperformed global indices in September. The NZX 50 was down just 0.66% in the first three weeks of September. In comparison, Australia’s ASX dropped 4.3% and in the United States the SPX was 3.7% lower.
But the Kiwi dollar may continue to suffer from a strong US dollar and falls in global commodity prices due to the continuation of aggressive rate hikes by the US Fed, and a slowdown in Chinese economic growth in the coming months.
Until the US Fed becomes less aggressive in its monetary policy, commodity currencies like the Kiwi may not be able to reverse the downward trend.
