Market Abuzz with Speculation of 75 Basis Points Rate Cut by Central Bank in November, BNZ Pours Cold Water

Comprehensive Report from Backyard on October 21:

Despite widespread discussions in the market about the Reserve Bank of New Zealand (RBNZ) potentially slashing the official cash rate (OCR) by a significant 75 basis points next month, BNZ economists caution that the threshold for such a substantial cut by the RBNZ is high.

After lowering the OCR from 5.5% to 5.25% in August, the RBNZ further cut it by 50 basis points on October 9, bringing the OCR down to 4.75%. Based on the third quarter Consumer Price Index (CPI) data, the annual inflation rate stands at 2.2%, below the RBNZ's forecast of 2.3%, leading financial markets to strongly anticipate further rate cuts in the future.

Currently, the pricing in the wholesale interest rate market reflects a total reduction of 100 basis points over the next two OCR reviews (November 27 and February 19 next year). The market expects a 58 basis points cut for the November review, indicating nearly a one-third chance of a 75 basis points rate cut.

In BNZ's latest 'Market Outlook' report, BNZ Senior Economist Doug Steel analyzed past instances where the RBNZ cut rates by 75 basis points or more, noting that while a 75 basis points cut at the November meeting cannot be ruled out, the threshold for such a large cut by the RBNZ is generally high. Therefore, BNZ maintains its forecast of a 50 basis points cut in November.

Westpac economists also expect that with inflation well under control, the RBNZ will cut rates by another 50 basis points in November, with gradual cuts continuing next year, bringing the OCR down to 3.75% by May next year.

Westpac Senior Economist Satish Ranchhod stated that last week's inflation data has bolstered the RBNZ's confidence in maintaining inflation around 2%, making them more comfortable with this month's rate cut. However, the market continues to fully price in a 50 basis points cut for the November and February meetings, reflecting concerns that inflation may significantly fall below 2% next year.

Ranchhod pointed out that current import price pressures are relatively mild, particularly in China, but he does not foresee a downturn similar to that of the 2010s.

He believes that New Zealand's economic cycle appears to have bottomed out, with retail spending still weak but showing slight increases over the past two months, and consumer and business confidence on the rise.

Nonetheless, Ranchhod stated that considering the lag effects of changes in New Zealand's monetary policy, the RBNZ might cumulatively cut rates by 125 basis points by the end of the year. Before doing so, they may want to observe how these cuts impact the economy, especially when domestic inflation remains high.

Ranchhod also mentioned that the RBNZ needs to be cautious of the overheating in the real estate market caused by rapid rate cuts in recent years. There are already signs of a recovery in the real estate market, with house prices rising by 0.2% in September.

Finally, he noted that the labor market will be a key area to watch. The unemployment rate rose to 4.6% in the second quarter, and the third-quarter unemployment rate, expected to be released on November 6, may further increase to 5.0%. If the deterioration in the labor market exceeds expectations, it will raise concerns for the RBNZ.

Editor: Tomato