- The RBNZ is set to lift the OCR to 3.5% next week, and deliver another “hawkish” commentary. Central banks around the world are battling the inflation beast. And we have yet to see a material weakening.
- We believe the RBNZ is gaining significant traction in their monetary tightening. Many mortgagees are rolling off very low rates and onto much higher rates in the next 3-6 months. Unfortunately, the RBNZ needs to see this pain in households before they are confident they’ll beat inflation back down to 2%.
- Financial markets are crumbling under the weight of higher interest rates. The risk of a global recession has risen substantially, and by central bank design. Traders have been quickly reminded that the Kiwi is a flightless bird when risk sentiment turns south.
On Wednesday October 5th the RBNZ is set to hike the cash rate by another 50bps to 3.50% - the fifth consecutive 50bp hike. And they will most likely follow up again in November with yet another 50bp hike to 4%. Aggregate demand remains too high relative to the Kiwi economy’s ability to meet it. Supply-side factors such as chronic staff shortages, and delays in deliveries of materials are keeping productive capacity constrained. A continued tightening of monetary conditions remains justified, for now.
We believe the RBNZ is gaining significant traction in their monetary tightening. Many mortgagees are rolling off very low rates and onto much higher rates in the next 3-6 months. Unfortunately, the RBNZ needs to see this pain in households before they are confident they’ll beat inflation back down to 2%. And inflation is a problem that refuses to back down.
Since the RBNZ last hiked interest rates in August, the risks to inflation are becoming more skewed to the upside. And the currency is now to blame.
In the last week, the weakness in the Kiwi dollar has become far more pronounced. Tradables, or imported, inflation is taking far longer to normalise. The RBNZ may be forced to signal even more policy tightening is needed. But next week’s MPR is only a small statement – with accompanying MPC meeting minutes – so doesn’t include an updated set of forecasts.
Global financial markets are highly sensitive to central bank moves. Bears, not bulls, rule equity markets. And bond markets have been savaged by rapidly rising interest rates. For many portfolios, there has been no place to hide. Well, there is one place, and that’s the US dollar. The US dollar is a safe haven for many in uncertain times. And as US interest rates rise at a faster pace compared to most other countries (esp. Europe and Japan), money is flooding into US dollar assets. The US Federal reserve is simply more hawkish than most. Other central banks are reacting with rapid fire rate rises. If they don’t, their currencies suffer even more as a result. And that’s inflationary.
Wholesale interest rates here at home have been pulled along for the ride. The rapid increase in Kiwi wholesale rates is putting even more (upward) pressure on mortgage rates and business lending rates. Although it’s not all about debt. Savings rates (term deposits in particular) are also rising.
Outside of the Kiwi dollar’s depreciation, global developments haven’t all been inflationary. Global supply-chain issues are clearly easing. Shipping container freight costs are easing (see our recent note). Moreover, global commodity prices have eased. Oil prices have fallen back to levels seen prior to Russia’s invasion of Ukraine. And projections of global growth have been lowered as fears of a global recession intensify.
For now, we continue to pick the peak in the cash rate at 4% in November. We believe the economic pain of such aggressive monetary tightening should be enough to tame the domestic inflation beast. The risk is clearly tilted to even more tightening, if the inflation beast refuses to retreat.
Domestic inflation drivers
Over the last six weeks or so domestic inflation drivers have barely improved. Nor have they worsened. On the data front, June quarter GDP growth rebounded at a decent pace from omicron disruption at the start of 2022. The GDP data was in line with the RBNZ’s forecast. But the report was mixed. It was good, bad and ugly.
There was good news. The border reopening has allowed international tourism to experience a sustained recovery. And the fall in the Kiwi currency will help all our exports going forward.
And there was bad news. The GDP data also showed a sharp fall in household and business spending. The sharp falls in spending was a concoction of weaker demand, and ongoing supply side disruption. An important distinction for the RBNZ concerned with sticky domestic inflation. Future data, such as next week’s business confidence survey from NZIER – released the day before the MPR – will shed more light on the state of local supply and demand imbalances.
Financial markets have been blitzed by central banks
In financial markets, we have seen an aggressive repricing of interest rates and the exchange rate. Inflation is public enemy number one. And central banks are stepping up their efforts to rein in the great inflation beast. Rapid fire rate hikes from numerous central banks have catapulted interest rates higher. The Kiwi wholesale interest rate markets have responded in kind. Market traders have now priced in a cash rate of 4.7%, well above the 4.3% of just a few days ago. The 2-year swap rate (the pivotal point on the Kiwi curve, used by banks to hedge 2-year fixed rate mortgage flow) has jumped from 4.15% in the middle of the month, to 4.74% today. Short end swap rates are now trading above the levels recorded during the spike in June. Bank mortgage rates are rising in response.
And then there is the Kiwi currency... In March, the Kiwi dollar was trading above 70 cents to the US dollar. Since then, we have seen a sharp decline. And the rate of decline has accelerated in recent days. The Kiwi is now trading at just 56 cents. There are three key influences on the Kiwi. Firstly, interest rate differentials (where our interest rates are trading relative to our peers – in this case the US) have the largest influence. The difference between Kiwi interest rates and US interest rates have narrowed quickly.
Secondly, commodity prices have started falling as global growth is expected to stall, and even contract in parts. The Kiwi is seen as a commodity currency given our large export sector, and dominance in primary exports. Finally, global risk sentiment has soured. The Kiwi always underperforms in a world with weakening risk appetite. The Kiwi dollar loves growth and confidence – even irrational exuberance. Whereas traders are quickly reminded that the Kiwi is a flightless bird when risk sentiment turns south.