The RBNZ delivered what was needed. Inflation is now in focus this week.

Published on 14 October 2024

The RBNZ ramped up the pace of rate cuts at its October meeting. The official cash rate was decreased by 50bps to 4.75%. The RBNZ's dovish pivot follows a series of datapoints signalling increasing spare capacity and thus further disinflationary pressure to come. It's a different story in the US. Recent upside surprises in labour market and inflation data have seen bets for another 50bp cut from the US Federal Reserve scaled back.

jarrod_kerr

Jarrod Kerr

Chief Economist

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Mary Jo Vergara

Senior Economist

Sabrina Delgado

Sabrina Delgado

Economist

  • The RBNZ cut the cash rate by 50bps to 4.75%, as we expected. It follows a 25bp cut at the August MPS. We expect another 50bps cut in November. The Kiwi economy needs it. We need a full reversal back to neutral, and that’s below 3%.
  • This week, we turn our attention to the RBNZ’s mandate, inflation. The RBNZ targets 2% in its 1-to-3% target band. And we’re close… really close. We think inflation will drop, swiftly, to 2.3%. And a 2.0% print is just around the corner. If anything, there’s a risk of undershooting.
  • Our charts of the week explores wholesale market pricing for future RBNZ rate cuts. Wholesale rates actually lifted last week, despite the 50bp move. And our special topic drills down into inflation.

The Fed may have kicked off its cutting cycle with a bold 50bp cut, but such a move is unlikely to be repeated. In recent weeks, market traders betting on a 50bp cut have been hit by a one-two punch. The first blow was the surprisingly strong September jobs report. Over 250k jobs were added and the unemployment rate unexpectedly fell. The US labour market remains robust. The second sucker punch was the upside surprise to September inflation. Headline inflation still fell, down to 2.4% from 2.5%, but just not by as much as expected. Core inflation did accelerate slightly to 3.3%yoy from 3.2%yoy. But to be clear, the latest numbers weren’t terrible. The monthly moves of headline and core inflation (0.2% and 0.3%, respectively) were consistent with the pace of the last year. If anything, the latest data shows that inflation in the US is stabilising. Nonetheless, the so-called ‘final mile’ of the return to 2% inflation, is proving to be a trek. Following the pair of strong September data, support for further large rate reductions has faded. Market pricing now has the Fed scaling back its rate cut to 25bp next month. And judging by the September FOMC meeting minutes, the bias among Fed officials seems to be for a more gradual easing cycle.

The RBNZ’s 50bp rate cut will support confidence.

We have some good news… we have some really good news. And you know what it is. Rate cuts are coming thick and fast… as needed. Bold calls for a 50bp rate cut last week were rewarded with the RBNZ matching market pricing. The cash rate has been cut 75bps from 5.5%, in August, to 4.75% today, with expectation of another 50bp move in November, to 4.25%. The key line in the statement:

“Members agreed that increasing excess capacity is leading to lower inflationary pressure in the New Zealand economy” (RBNZ, Oct24).

A 50bp cut was deemed the “most consistent with the Committee’s mandate of maintaining low and stable inflation, while seeking to avoid unnecessary instability in output, employment, interest rates, and the exchange rate” (RBNZ, Oct24). Given market pricing, a 50bp cut was always going to cause the least market reaction – as was the case. A 25bp cut would have caused a stir.

Restrictive interest rates have done enough to depress domestic demand. Since the end of 2022, we have been in recession. Spare capacity is building in the economy. Unemployment is on an upward trajectory. We forecast the unemployment rate exceeding 5% by year-end. The labour market lags economic activity by about 9 months. So, there is more pain to come. With greater spare capacity comes further disinflation pressure. That’s needed. Because domestic inflation is still too high. For more detail, please see: “Tack and jibe like an AC75. The RBNZ delivers 50bp!”

Turning to this week, we wait with bated breath for the September quarter inflation report on Wednesday morning. We’re expecting good news (see our preview). By our calculations, we see inflation slowing to 2.3% from 3.3% - the lowest in more than three years. Over the quarter, we expect consumer prices rose 0.8%, an acceleration from the 0.4% lift in the June quarter. It’s not unusual to see September quarters post relatively large increases in CPI as it captures the annual review in council rates (3% of the CPI basket). And this year, we’d expect to see a large increase. Providing a meaningful offset is deflation in the imported prices. Our forecasts are in line with the RBNZ’s expectations.

We can thank tradables inflation for driving headline inflation back within the band. Fuel prices have been especially weak. According to StatsNZ, petrol prices declined almost 7% last quarter (helped by the removal of the Auckland regional fuel tax).

We expect annual tradables to fall into negative territory (deflation), from 0.2% to -1.6%. Domestic inflation, in contrast, is a slow-moving beast. The good news is that it has turned. We expect annual non-tradables to slow to 5% from 5.4%. It’s some distance from the 6.8% peak, but still sitting high above the long-term average (~3%). A more meaningful slowing in services inflation is needed to ensure a sustainable return to 2%.

Financial markets

The comments below were provided by Kiwibank traders. Trader comments may not reflect the view of the research team.

In rates, the RBNZ met the market

“The RBNZ delivered the -50bp cut the market had been hoping for, reinforced with dovish “still restrictive” overtones. Pre RBNZ meeting -42bp of easing was priced and -88bp priced into November, as a result yields fell in the 1 year by -9bp, 2 year by -4bp and 5 year by -2bp. Most market observers now expect a follow up -50bp (-54bp priced) cut at the November meeting, and -25bp (-39bp priced) in February. Some of this bring forward as a result of the post November meeting hiatus until February, over that NZ holiday period the FED meets twice. There is NZ CPI this week, Employment data on 6 November, a weakening budget deficit, and a line-up of RBNZ speeches starting today to navigate. Overlay the domestic backdrop with a US election, another FED meeting, and the potential for more China stimulus and it won’t be an easy decision come the RBNZ November .

Outside the repricing as a result of the -50bp cut the rates market reaction to the RBNZ was fairly muted. There will continue to be some toying with the idea of a -75bp cut, with -54bp priced for November, and one offshore bank calling for it. That outlier call could be joined if data weakens further. With all the talk about the timing and magnitude of cuts it’s easy to lose sight of the end point. At the moment that is priced in a 2.80-3.00% range, but market commentators have a more diverse opinion, with some as high as 3.75%. Regardless of opinions the market pricing for that end point has remained relatively anchored in that range, and in reality we won’t know the end point until we’re there (as we saw with the start point).

Given CPI is expected to fall from 3.3% down to around 2.3%(RBNZ pick also) a large sell-off in yields looks unlikely, more so as the deflation drum beats louder as we approach 2.00%. Any offshore led sell-off will be reflected in a steeper curve, which in NZ is already a cycle highs and likely to buckle anytime soon with more bonds issuance in the wings (NZGB30’s syndication). The once dovetailed US and NZ monetary policy setting are beginning to diverge, the NZ hard(er) vs US softer landing dynamic playing out in the respective yield curves which suggest a bottom to US rates.” Ross Weston, Head of Balance Sheet – Treasury.

In currencies, the Kiwi dollar now awaits our CPI print

“Last week the RBNZ delivered a much needed 50 bp cut to the OCR. This was what dominated the Kiwi dollar last week. US CPI was also a hot contender, but didn’t have much of an impact on the Kiwi in the end. With the market broadly expecting a 50bp cut from the RBNZ, it was of little surprise to the market, but it did have an impact on the Kiwi nonetheless, as traders looked immediately to the November meeting and beyond. The Kiwi opened last week at the 0.6160 mark, and trailed lower to 0.6130 in the lead up to the RBNZ decision, and then on Wednesday following the 50bp OCR cut, dropped to a low of 0.6098. After initially finding some support around the 0.6100/6110 mark, the Fed meeting minutes saw a boost to the US Dollar, which sent the Kiwi lower again to 0.6054. Then looking a little oversold, short position covering and a lift in longer dated bond yields saw the Kiwi recover some ground, ultimately closing out the week at 0.6110. The NZDAUD cross opened the week around 0.9100 then hit a low mid-week of 0.9016 before closing the week at 0.9050. So still very much in that ‘painted on’ range for the cross. Going forward, we expect that the Kiwi will continue to slowly fall from here. In our latest FX Tactical we laid out the argument for the Kiwi to be trading at 0.5900 by year end, and this looks like the most likely outcome at the present juncture. With the RBNZ expected to continue cutting, and not waste time with it, the Kiwi should track lower as the interest rate differentials play out amongst the G10 currencies. The US market is now expecting a more moderate pace of cuts from the Federal Reserve, as they look more and more likely to have achieved the ‘soft landing’ they were looking for, as the US labour market remains resilient. And positive news for the Kiwi dollar looks a bit thin on the ground. After initially gaining some steam from the promised stimulus for the Chinese economy, this is now petering out as data out of China continues to highlight the real struggle in their economy, as well as a lack of details from China’s officials on the finer details of fiscal stimulus. We also have Middle Eastern geopolitical tensions on the slow boil. This week we have our CPI print, and as we get closer to the 2.0% inflation target rate, the bets on further cuts and what the terminal rate ends up being should give the Kiwi a push lower from here. Upside (towards 0.6250) for the Kiwi is likely if the CPI print is hotter than anticipated.” Mieneke Perniskie, Trader - Financial Markets.

The week ahead

  • The September quarter inflation report is the main domestic event this week. Headline CPI inflation is expected to fall back within the RBNZ's 1-3% target band. From 3.3%yoy, inflation is expected to print at 2.3%. A rapid deceleration in imported inflation continues to pull down the headline rate, while domestic pressures remain strong. The labour market has softened in recent months, which may show a slowdown in services inflation. Core inflation has also been trending south, and may fall back within the band in the September quarter.
  • Across the Tasman, jobs growth likely slowed in September with a 24k expected increase in jobs, fewer than the almost 48k gain in August. Labour supply continues to rise due to high levels of migration and labour force participation. The unemployment rate is expected to stay unchanged at 4.2%.
  • In the US, retail sales and industrial production are the datapoints to watch this week. In September, retail sales growth likely picked up the pace, up 0.3% from 0.1%. Consumer spending continues to grow at a modest pace, with a slight rebound in vehicle sales. Industrial output likely declined in September, down -0.1% from 0.8% growth in August. Survey data points to a slowdown in manufacturing production, and labour market data showed a decline in hours worked within the industry,
  • The European Central Bank is widely expected to announce a 25bp cut to its main policy interest rates this week. Inflation has now fallen below the ECB's 2% target, and recent business surveys suggest downside risk to the ECB's growth outlook. Financial markets also expect another 25bps at the November meeting as well.
  • In the UK, the latest labour market and inflation data are due out this week. First, the unemployment rate is expected to stay unchanged at 4.1% and wage growth likely slowed. In the three months to August, whole economy wage growth is forecast to fall to 4.9% from 5.1%. Inflation likely eased to below 2% (1.9%) in September from 2.2%, driven by softer services inflation. A fall in fuel prices over the month will also help to drive the headline rate lower. The data will be important for the Bank of England's November policy decision.
  • Japan's September inflation is due out this week, and expected to ease to 2.5%yoy from 3%yoy. Core inflation (excluding fresh food) is also expected to slow to 2.3%yoy from 2.8%yoy. The slowdown is driven by utility subsidies, and should prove temporary. Inflation is expected to rebound in the coming months, as companies pass on higher labour costs and import costs (due to a weak Yen) onto consumer prices.
  • Several Chinese economic datapoints are due out this week, all which will likely show the growth slowdown deepening. GDP growth likely slowed in the September quarter, from 4.7%yoy to 4.6%yoy, due to weak consumption and investment. September activity data may show a small improvement, with industrial production edging slightly higher (from 4.5%yoy to 4.6%yoy) and retail sales growth rising to 2.5%yoy from 2.1%yoy.

See our Weekly Calendar for more data releases and economic events this week.