RBNZ’s surprise rate cut shows how quickly the RBA could change its tune

A surprise rate cut in New Zealand showed how fast central banks can change their tune when data make the case to do so.

CBA’s Gareth Aird

As much as the Reserve Bank remains hawkish, a surprise rate cut in New Zealand showed how fast it could change its tune if the data make the case to do so.

It wasn’t great for Aussie banks, as NZ mortgage interest rate cuts will trim net interest margins. But the NZ sharemarket rose about 2 per cent and NZD/AUD fell 1 per cent.

Australia’s inflation rate is about 3.8 per cent and not expected to hit the 2-3 per cent target band on an underlying basis until late 2025. NZ inflation is about 3.3 per cent and expected to hit 2.4 per cent in the September quarter versus RBNZ’s 1-3 per cent band.

But inflation is falling in both countries, and inflation expectations remain low.

“It certainly shows how central banks can change their tune when the data makes the case,” said CBA’s head of Australian economics, Gareth Aird. “History shows central banks do so frequently if the landscape doesn’t evolve in line with their expectations.

CBA is the only major bank that still expects the RBA to start cutting rates in November.

Last month, the RBNZ appeared to start setting up the markets for a rate cut. But two months earlier, it was very hawkish on interest rates.

In May, the RBNZ said NZ Inflation was expected to return to its target by the end of 2024. However, it said, “a slow decline in domestic inflation poses a risk to inflation expectations”.

NZ inflation had “fallen more slowly than expected,” the RBNZ said at the time.

“Persistence in non-tradable inflation remains a significant upside risk,” they said. “Policy needs to remain restrictive to ensure inflation returns to target within the forecast timeframe.”

As the RBA did this month, the RBNZ even went so far as to “discuss the possibility” of a hike in May.

At that time, the RBNZ’s forecasts projected the official cash rate would end 2024 at 5.7 per cent, implying that it was poised to lift interest rates again this year.

However, even at that time, the RBNZ wasn’t as hawkish as the RBA has been this month.

Last week, RBA governor Michele Bullock said the central bank “will not hesitate” to hike rates again if needed.

RBA governor Michele Bullock delivers the RBA's monetary policy decision and rates announcement last week. Picture: John Appleyard/NewsWire

“Over the past 25 years the RBA has never hiked rates within three months of the RBNZ, US Federal Reserve and Bank of Canada all easing,” said ANZ’s head of Australian economics, Adam Boyton. “Two of those three have now eased, one is likely to next month.”

Fast-forward three months and the RBNZ now projects its cash rate will end 2024 at 4.9 per cent, implying another 25 basis point rate cut on top of the cut it announced Wednesday.

In May, the RBNZ projected an OCR rate of 5.10 per cent at the end of 2025.

Now it expects the official cash rate to hit 3 per cent by then. But while the RBNZ says its “neutral rate” is 2.75 per cent, Australia's neutral cash rate is closer to 3.5 per cent.

NZ economic weakness has “become more pronounced and broadbased,” the RBNZ said,

“Surveyed inflation expectations, firms’ pricing behaviour, headline inflation, and a variety of core inflation measures are consistent with low and stable inflation.

“Services inflation remains elevated but is also expected to continue to decline, both at home and abroad, in line with increased spare economic capacity.”

NZ inflation was “expected to remain near the target mid-point over the foreseeable future.”

Perhaps NZ will reap the benefits of its early and larger scale rates hikes.

NAB head of market economics, Tapas Strickland, saw no direct read through for Australia, primarily because the RBA didn’t hike as much as the RBNZ.

He also noted a contrast in the monetary policy discussions that led the RBNZ to cut.

The RBNZ said that alongside restrictive monetary policy, an earlier or larger impact of tighter fiscal policy, together with falling net migration, could be “constraining domestic demand.”

In Australia, fiscal policy loosened with tax cuts and state and federal subsidies in mid-2024.

In its policy decision last week, the RBA saw a slightly slower return to its inflation target than it forecast in May, based on estimates that the gap between aggregate demand and supply in the economy is “larger than previously thought”.

“In part, this reflects an increase in the forecast for domestic demand,” the RBA said. “It also reflects a judgement that the economy’s capacity to meet that demand is somewhat weaker than previously thought, evidenced by the persistence of inflation and ongoing strength in the labour market.”

But the RBNZ said the output gap in NZ is “more negative than assumed” in May, showing “increased spare capacity” in the economy. On NZ fiscal policy, it said government expenditure is declining as a share of the economy, with contractionary impacts already felt and expected to continue.

And whether tax cuts will boost consumption was “more uncertain.”

“While tax cuts could stimulate demand, it is also possible that households might be more cautious about spending in the current economic environment,” the RBNZ said.

The RBNZ also said that measurement challenges were: “creating additional uncertainty around the composition and likely persistence of this weakness.”

But the RBA saw a “risk that household consumption picks up more slowly than expected, resulting in continued subdued output growth and a noticeable deterioration in the labour market.”