Where to next for interest rates post-CPI? What the markets say

Reserve Bank of New Zealand Governor Adrian Orr. Financial markets are pricing in interest rate falls as early as November this year. Photo / Mike Scott

The financial markets and economists are largely on the same page in terms of where interest rates go next after this week’s lower-than-expected inflation outturn.

There is broad agreement that the Reserve Bank will probably raise its official cash rate (OCR) by 25 basis points from the current 5.25 per cent at its next opportunity on May 24, and that 5.5 per cent will represent the peak.

But where the markets and economists part company is further down the track.

Market pricing suggests a rate cut will be on the cards by November this year, while economists say it will be well into 2024 before the Reserve Bank looks at relaxing its stance.

“That [a November rate cut] is not impossible, but our expectation is that it will not be until May of next year,” Westpac senior markets strategist Imre Speizer said.

“The reason for that is that inflation is only now just starting to turn the corner, and the Reserve Bank will want to see it firmly on a downward track,” he said.

The Reserve Bank’s target is to shoehorn inflation into a 1 to 3 per cent annual range.

The CPI’s March year outturn of 6.7 per cent suggests more work is required.

“It would take something quite surprising to happen for the Reserve Bank to start thinking about rate cuts,” Speizer said.

“Markets want to be pre-emptive and markets want to speculate, because that’s where they make their money,” he said.

“They want to be first and to put those bets on, and that’s why we have seen pricing swing so much below where most economists are at,” he said.

“They are not on the wrong track,” he said.

“There will be an easing cycle coming up, it’s just that they might be quite early in this case.”

ASB senior economist Mark Smith said the CPI release effectively quashed any notions of the next move being a 50-basis-point hike.

Smith said the CPI outcome suggested OCR rate hikes to date may have gained traction in the fight against inflation.

“They [the Reserve Bank] are encouraged by that, so I don’t think there will be as much urgency to hike,” Smith said.

“The area where economists differ from the markets is that the markets are pretty aggressive on rate cuts from the peak of the OCR around July.

“From then, markets have got about 160 basis points of cuts through to the end of next year, which would see the OCR back to 4 per cent,” Smith said.

“That’s probably where we differ from market pricing.

“The general view among economists is that the Reserve Bank will probably maintain on a restrictive setting for a bit longer than that, and start to cut a bit later,” he said.

“The direction of travel will be similar, but I think the market is probably earlier than ASB’s view.”

ASB’s take is that OCR cuts will only be contemplated when sub-3 per cent CPI inflation is in prospect, which is unlikely to be seriously considered until well into 2024.

Two-year swap rates - which have a bearing on home mortgage rates – dropped after the CPI’s release and have continued to head south.

They traded today at 5.02 per cent from 5.24 per cent before the release.

Similarly, the New Zealand dollar has continued to fall, reflecting the market’s view that some of the tightening pressure has come off the Reserve Bank.

The currency was last at US61.55c, down almost a US cent from its pre-CPI level of US62.40c, and a five-week low.