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At the RBNZ’s OCR Review on October 29, the Bank halted its cutting cycle and left its key policy interest rate unchanged at 2.75%. The RBNZ has reduced the OCR from a rate of 3.50% in June down to the current rate of 2.75%. We expect to see one further rate cut at the RBNZ’s next meeting on December 10, taking the OCR back to 2.50% - its post-GFC low. While the cash rate is not back at its record low yet, mortgage rates have been reduced to the lowest levels in over 30 years for some terms. Because wholesale interest rates (which banks largely set their deposit and lending rates off) are priced for one more OCR cut, we may not see significant further reductions in fixed terms even if we see another rate cut in December.
There’s also an increasing risk that the RBNZ may need to cut the OCR below 2.50%, and two such risks have recently been highlighted by the central bank. If the OCR was cut further, this could see wholesale rates (along with banks’ deposit and lending rates) decline further. The first scenario that could prompt a new low in the OCR is a significant deterioration in the global growth outlook. This would cause demand for our exports to decline sharply, reducing incomes for exporting and manufacturing firms. The biggest risk to these groups would come if we saw the economic outlook in China and Australia weaken, as these are New Zealand’s two biggest export destinations (in total they account for about 40% of our exports).
The second risk noted by the RBNZ is if the exchange rate remains elevated at current levels, or rises even further.
The NZD/USD exchange rate declined from $0.77 in late April down to $0.63 in September, before recently rebounding up to around $0.65. A broader measure of the exchange rate, the trade-weighted index (TWI), is currently tracking between 6%-7% higher than the RBNZ’s most recent forecast for the December quarter (see chart). A higher exchange rate reduces the prices for goods and services imported into NZ, increasing the possibility that inflation will continue to fall short of the RBNZ’s target of 1%-3% over the medium term. Consequently, the RBNZ noted at the October OCR Review that an elevated exchange rate “…would need a lower interest rate path than would otherwise be the case”.
While our central view remains for the OCR to be cut to 2.50% in December, and hold steady until at least the second half of 2017, there remains a risk that the OCR may need to be cut even further.
The latest set of labour market data showed that employment growth in New Zealand dropped by 0.4% over the September quarter – the first decline in employment seen since September 2012. This means that 11,000 fewer people were employed relative to June, although the number employed over the past year is still 34,000 higher than a year ago. Interestingly however, the entire decline in employment was due to a large drop in the number of people working part-time, while full-time employment actually increased marginally. Part-time employment is historically more volatile than full-time employment so we could see a bit of an improvement again in the December quarter.
Over the past year we’ve seen a record increase in net migration of over 60,000 people, boosting NZ’s working-age population by 2.2% yoy. As the population continues to expand, employment demand now appears unable to keep up with the rising number of people searching for work. Employment growth has pulled back from an annual pace of 3% in June, down to 1.5% yoy in September. The unemployment rate increased to 6% in September, but we expect this will creep higher in coming quarters. For employers this means it’s likely to get easier to hire new workers as the availability of people looking for work increases. For employees however, this means an increasingly competitive job market, particularly in some fields where employment is declining (see chart below).
The construction industry has continued to exhibit the largest increase in employment, but there has been a clear shift in focus from the Canterbury region dominating demand, to most of the growth now coming from Auckland instead. Of the additional 20,500 people hired in construction over the past year, almost three-quarters of those new workers were located in Auckland, while another 5000 were hired in Canterbury. After construction, the retail trade, accommodation and food group has seen strong demand for new workers, with an additional 15,000 people employed in the industry over the past year. The retail trade and accommodation sector has been experiencing strong growth on the back of the expanding tourism sector, contributing to rising demand for workers.
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