RBNZ August Monetary Policy Statement Review
Pulling the punches on lockdown news
Written by Zoe Wallis & Liana Allan
Up until Tuesday night, it was widely expected that the Reserve Bank of New Zealand (RBNZ) would lift the OCR from 0.25% to at least 0.50%, with several commentators posing the prospect a 50bps hike. Capacity pressures in the NZ economy have risen substantially and based on the economic outlook as it stood up until 17 August, it was clear that the OCR could comfortably move away from emergency settings. However, in the wake of the Level 4 lockdown being implemented across the country, the RBNZ left the OCR on hold at 0.25% at its August Monetary Policy Statement (MPS). It was clear though from the RBNZ’s commentary and forecasts that a hike had been on the table up until the previous day. The announcement of a community outbreak of the Delta variant of COVID-19 and the subsequent Level 4 lockdown for the entire country has meant the economic outlook became significantly more uncertain and the Bank, quite rightly, erred on the side of caution and chose to delay hiking.
Lockdown reality hits
At this stage, Auckland and the Coromandel Peninsula will remain under Alert Level 4 for at least seven days, while the rest of the country will be in lockdown for at least three days. Both these lockdowns are very likely to get extended, especially given the Delta variant is more contagious and dangerous than other variants of COVID-19. At the time of writing there have been 21 community cases identified with the risk that the actual number could be over 100. For context, in March 2020 the country went into Level 4 lockdown for a period of four weeks with 102 confirmed community cases – this was of the less contagious original COVID-19 variant. We then moved down to Level 3 for three weeks and then to Level 2. If the country follows a similar 6-7 weeks’ timeframe to move back to Level 2 then this could cause a sizeable dent in economic activity. While lockdown is acknowledged as critical for virus containment, it has a significant economic impact. Treasury and RBNZ estimate GDP is about 40% lower during Alert Level 4. However, demand recovered quickly from the last major lockdown and consumers spent up big on hospitality, apparel, and durables in the months directly after moving down to Levels 2 and 1. Consumer and business confidence both bounced back convincingly, with business confidence at higher levels than it was before the pandemic started. As illustrated in Figure 1, consumer spending took a hit in several areas during the last nationwide lockdown but quickly bounced back and is now stronger than it was pre-pandemic in some sectors.
The reality is that we may well be in for a similarly long lockdown again this time around but, if well managed, the corresponding bounce-back in economic activity could be similarly positive to what we saw over the second half of 2020.
Current inflation spike expected to moderate over next couple of years
On inflation the RBNZ highlighted that some of the currently rapid price appreciation is being caused by one-off factors due to higher oil prices and supply chain issues. While this is true, price pressures appear to be widespread and may continue for some time. The RBNZ is forecasting inflation to reach 4% in the current September 2021 quarter before supply-side disruptions ease from early 2022 and this, combined with forecast OCR increases, should start to take some of the heat out of the economy and see inflation return to around 2% from mid-2022. Most of the medium-term inflation pressure is expected to be driven through domestic/non-tradable inflation (the price of goods and services which aren’t competing with international imports). This is partly driven by a combination higher costs of construction-related components in the consumer price index (CPI) and capacity pressures continuing for some time – in particular, a tight labour market.
Labour market at full capacity
In terms of the labour market, with an unemployment rate of 4% and a very competitive labour market, the RBNZ noted that unemployment is “at or above its maximum sustainable level in the current environment”. The Bank is forecasting the unemployment rate to dip slightly further down to 3.8% in a years’ time and then remain at around 4% over the next few years. Wage growth is rising and the RBNZ expects wage inflation to reach 2.7% yoy at the end of 2021, similar to our own forecasts, peaking at a rate of 2.9% yoy.
Housing market viewed as unsustainable, small correction to come
The RBNZ still expects to see house prices moderate, with the Bank forecasting house prices to decline from the start of 2023, with a decline of almost 3% expected over the 2023 year and a further small decline in 2024. The Bank’s view is that lower population growth due to closed borders, combined with a significant pipeline of building consents should see house price inflation moderate significantly in the next couple of years. In our view, house price inflation is likely to moderate as interest rates rise and affordability constraints bite. However, we have concerns that the supply that is promised to come on board may not eventuate due to a variety of capacity constraints in the construction sector- including an acute shortage of labour and materials.
The prospect of further tightening in LVR restrictions – as has been mooted by the RBNZ – could take further heat out of the housing market. Debt-to-income ratio restrictions could also reduce the availability of credit and hence remove some buyers from the marketplace, helping to rebalance supply and demand for housing.
What happens next?
Interest rate hikes will happen in the near future, absent a major economic downturn occurring. The RBNZ has clearly signalled that they were ready to pull the trigger on an OCR hike this month and follow this up with subsequent interest rates hikes to ensure they maintain their inflation mandate. The big question now is around timing and that will largely come down to how prolonged the current lockdown is and how fast the economy bounces back again as we move back down alert levels. If this lockdown proves to be short, sharp, and successful, the economic recovery will likely be slowed but not derailed. A return to near-normal conditions is key to GDP growth, especially as growth will remain hindered by continued border closures and capacity constraints. On the other hand, unsuccessful containment of the Delta variant risks leaving us in a similar position to our Australian neighbours. If the former proves to be the case, the RBNZ may look to raise the OCR at its next update in November, while the latter could see the Bank take a more cautious approach and retain more stimulatory policy settings until at least 2022.
In terms of how far the OCR could go once the RBNZ does commence hiking, the answer is likely to be not nearly as high as it has been in the past. The Bank’s estimate for the neutral cash rate is now just below 2%, with the Bank expecting to move the OCR up to just above 2% by the start of 2024. Our view prior to the lockdown announcement was that the RBNZ would move reasonably quickly to get the OCR back toward 1-1.25% by early 2022. The MPS projections now suggest that the OCR will reach that level by September 2022 instead – a delay most likely caused by the thwarted commencement of rate hikes this month.
In our view, the RBNZ made the best of a tough situation with its August MPS and took the path of least regret in delaying hikes. If/when the OCR starts to move higher, and by how much, is now highly dependent on health outcomes relating to the most recent Covid-19 outbreak and how that plays out for the NZ economy.