OCR rates cuts should dominate next year
The worse than expected GPD result for the September quarter could mean cuts to the OCR may kick in next year – much sooner than the RBNZ is predicting.
Thursday, December 14th 2023, 2:11PM 
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by Sally Lindsay
In a shock to economists, the economy contracted -0.3% and the technical recession over last summer that was “technically” revised away has been revised back in.
The Kiwi economy is in a much weaker place than originally thought. Economic activity on a per person basis, contracted 0.9% in the third quarter, and the economy is down more than 3% over the year.
The RBNZ’s heavy hand has hurt households and businesses. Restrictive monetary policy is clearly working, say Kiwibank’s chief economist Jarrod Kerr, senior economist Mary Jo Vergara and economist Sabrina Delgado.
“The recession they told us we had, then never had, appears we had to have. And it will most likely be a double dip recession,” Kerr says.
Kiwibank’s economists are expecting another contraction in the fourth quarter and probably the first quarter of next year.
“The point here is simple,” Kerr says. “We have a smaller economy and the Government has a smaller tax base. The economy is a lot smaller than RBNZ forecasts. Inflation pressures are also likely to be less intense, given the falls in production. And all of this was despite the colossal surge in migration.”
Financial markets have reacted swiftly to the weak numbers. Rates are down a lot and the currency is down, a little. Talk of rate cuts are dominating.
Traders are betting on OCR rate cuts, not hikes and Kiwibank agrees.
Before the GDP report this morning there was a sharp drop in wholesale interest rates.
Kerr says financial markets were shocked by a “dovish” US Federal Reserve this morning.
The famous ‘dot plot’ shows 75bps of cuts next year. Whereas the RBNZ has the risk of a hike, and no cuts until September 2025.
“The Fed is far from call victory on inflation, but it has most likely done enough to win the war on inflation, and is discussing rate cuts. Unlike the RBNZ, the Fed effectively endorsed market pricing for rate cuts next year. Whereas the ‘impatient’ RBNZ is trying to reverse market pricing for cuts.”
Fed President Jay Powell was quite ‘dovish’ in his remarks, following a substantial pivot towards rate cuts. Kerr says.
“In the press conference, there was one question and answer worth a mention. When asked about the start of rate cuts, and the level of inflation, he said you would need to start cutting well before inflation actually hits 2% - because of the likelihood of undershooting.
“So if inflation hits 2.5% and looks to be moderating, they start cutting so not to risk inflation going to 1%.”
Kerr says this is very different to the bank’s friends on The Terrace in Wellington.
“We asked the RBNZ the same question in November. And it said it wants to see 2% before cutting. So, the RBNZ sees inflation hitting 2% in September 2025. And cuts follow.
“One is right, one is not as right. We like the Fed’s approach to cut well before hitting 2%. It’s all too easy to forget the low inflation era, prior to Covid. And we find it hard to believe the RBNZ will be on hold until late 2025 – that’s more than two years of sitting on its hands.”
Kiwibank thinks the RBNZ will start cutting in November next year – a year ahead of its own projections. And an earlier move is also possible. The bank argues an earlier move is more likely that a later move in 2025.
“When looking at current pricing, Kerr says the bank is probably a little too optimistic on the outlook for inflation, and rate cuts. Yields may back up, and bounce 20-30bps off today’s lows.”
However, he says we are trading in a lower trading range from here. Because rate cuts, not hikes, should dominate discussions next year.
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