The Reserve Bank (RBNZ) may have to get into a fight with financial markets as it tries to bring inflation back within its target range, according to a new report.
Westpac Bank’s latest report said that financial markets have been quick to anticipate the next phase of monetary policy and were pricing in cuts to the official cash rate (OCR) as early as the second half of 2023.
But Westpac’s forecasts suggest the RBNZ would not cut the OCR until 2024.
“This is an area where the Reserve Bank might need to pick a fight with financial markets,” Westpac acting chief economist Michael Gordon said.
“Markets by their nature are always trying to anticipate the next move the Reserve Bank makes.
“Now, they’re getting to the stage where [we’re] starting to see the end of rate hikes, so the next stage must be interest rate cuts and they’re starting to factor those in. “
Gordon said he did not think the Reserve Bank would want to encourage that view, given the RBNZ’s priority was to wrestle inflation, which is currently at 7.3 percentback within its 1 to 3 percent target range.
“This is not simply a matter of Old King Cole, marching up a hill just to march straight back down again,” he said.
“This is about finding a setting for interest rates that will help to take the heat out of inflation without requiring something more dramatic in terms of a bigger downturn in activity or a bigger rise in job losses.”
Westpac’s economist expected the OCR to peak at 4 percent by the end of this year and did not expect to see any reductions in the cash rate until the second half of 2024, when inflation was about 2.9 percent.
“For me, it’s not really so much about the level that it peaks at, it’s really how long it’s sustained at that level for,” Gordon said.
The Westpac report said while the current inflation picture was “grim”, there was reason to believe consumer prices have peaked.
“Some of the previous prices have flattened off or, in some cases such as oil, have started to reverse.”
The bank expected inflation to fall to 5.1 percent by the end of 2022.
The report said the economy was now at a turning point, as the impact of higher interest rates was becoming more pronounced and economic growth was set to “shift down a gear”.
A recession was off the table, but the Westpac’s economists forecast gross domestic product would slow to 1.8 percent for 2022 and reach about 2 percent by the end of next year.
“That would be a sizeable step down from the rates of 3 percent to 4 percent per annum we saw prior to the pandemic,” the report said.
A tail wind for the economy was the current strength of the labor market and the reopening of the border, it said.
Tourists would provide some offset to the softening in domestic demand, as international visitor numbers were climbing rapidly since the border with Australia reopened earlier this year, it said.