Chart 1: This is how it starts
Remark: There was nothing in the Reserve Bank announcement that significantly challenged our view of the world. The Official Cash Rate was cut by 25bps to 5.25 per cent, as we expected. The interest rate brake is still on, but less than before.
The most important aspect of the meeting for us was the confirmation that the OCR will decline significantly over the next 18 months.
It has to be. Our rough estimate of the 'real' (inflation-adjusted) cash rate has been rising in recent months, even with this week's cut. And it's a long way down for the OCR to the Reserve Bank's estimate of the long-term neutral rate of around 3 per cent.
Graph 2: Chop
The Reserve Bank's updated forecasts were a shadow of their former selves. GDP growth, inflation and OCR forecasts were slashed, while expectations for the unemployment rate were raised by around half a percent to a peak of 5.5 percent.
This brings the Reserve Bank’s view of the economy back to, or even a touch weaker than, where we have seen things to date. Importantly, CPI inflation is now well within the 1-3 per cent target range in Q3 (2.3 per cent y/y from 3.0 per cent in May). We agreed with that yesterday.
It means there is a higher threshold for incoming data to surprise the Reserve Bank on the downside. That doesn’t rule out a larger 50bps OCR cut at some point, but it does lean toward the possibility in the near term.
Chart 3: Participating in the interest rate race
After a period of being the odd one out, New Zealand is now back in the peloton of policy easing, with most developed markets expecting significant rate cuts over the next 12 months.
Markets are pricing in the likelihood that the US Federal Reserve will begin a 50 basis point easing cycle next month, which if implemented could lead to further global rate cuts.
Of the markets covered against this, implied policy easing through February 2025 is most aggressive for the US (-185 bps), New Zealand (-150 bps) and Canada (-130 bps), with Australia (-65 bps) and Japan (+10 bps) at the other end of the spectrum.
Chart 4: Colds in the US
Global financial markets have regained much of their equilibrium after the stock market’s steep declines early last week. However, sentiment is not what it used to be. Investors are suddenly aware of a number of global vulnerabilities.
Much of the blame for the swing has been placed on the exuberance of cooling technology/AI and concerns about US growth. Last week’s outsized reaction may reflect the additional, creeping reliance on the US to drive global expansion this year. The old adage ‘US catches a cold’ is still relevant
Graph 5: Job growth stagnates
The number of people in employment rose 0.4 percent in the June quarter, according to official figures released last week. We had priced in a small decline. Unemployment still rose to 4.6 percent, as expected.
It is unlikely that the second-quarter employment growth will be repeated this quarter. It also does not change the general picture that job growth will essentially plateau around mid-2023.
The sector-specific details clearly show that the construction sector is at the forefront of the changing labour market.
Graph 6: Moving for work
The increase in New Zealand's unemployment rate in the second quarter meant that the gap with the Australian equivalent (4.1 percent) was still 1/2 percentage point.
That may not sound like much, but it's the biggest difference since 2013. It's no coincidence that net migration flows to Australia are also at their highest level since 2013. People are moving to where the jobs are.
Our forecasts imply that both trends have a long way to go. An increase in New Zealand’s unemployment rate to a peak of 5.5 percent in early 2025, compared with a lower peak (4.6 percent) in Australia, would be consistent with an acceleration in net outflows based on past data.
Graph 7: Green flags
Wage inflation peaked in New Zealand about a year ago. We saw another step in the downward trend last week. The private sector Labour Cost Index fell to 3.6 percent y/y in June, down from 3.8 percent in the previous quarter and a peak of 4.5 percent.
More of the same easing is expected over the next 12 months. It is something that should help to reduce the still high inflationary pressures from domestic services. So it is not that high interest rates have not been effective for non-tradables inflation, it is that the impact is only felt over time. The lags are real!
Chart 8: No respite for retail
The trend in retail card spending in New Zealand abruptly reversed in early 2023 and has been on a downward trajectory ever since. The 0.1 percent m/m contraction in July was the 6and consecutive monthly decline. Discretionary categories remain hardest hit.
The weakness is even more pronounced when strong population growth is taken into account. Our estimate of average monthly expenditure per person (of working age) is 8 percent below the March 2023 level. It is a deeper and longer contraction than during the 2008 GFC.
We hope that the downward trend will stabilize soon. Tax and interest rate cuts are support, but declining population growth and job security are not.
Graph 9: Housing market in pictures
The publication of the REINZ housing market figures for July has been postponed until Tuesday and is therefore not included in this edition of TEITC.
But it’s fair to say that housing statistics are being watched more closely than usual as people look for green shoots in a sector that is likely to be one of the first to react to (recent and expected) falls in retail rates. There is some anecdotal evidence and research that does some good, but we think the outlook is more stabilisation than acceleration for now.
At the very least, we expect a strong rebound in sales activity in July after the disproportionate fall in June, linked to the Matariki holiday, as we saw in this week's Barfoot & Thompson figures for part of the Auckland market.
Chart 10: Food for the mind
Food prices rose 0.4 percent m/m (seasonally adjusted) in July. Prices were flat over the past year, but they are still 24 percent higher than in 2020.
As you might expect, there has been quite a bit of variation between the components over that time. If you like an omelette and/or yogurt for breakfast, you will feel the pinch a lot more than others. At least your morning brew is still, relatively speaking, cost-effective.
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