OCR Preview: More interest rate relief coming...but how much and where to next?

Economists and financial markets are united in their expectation the Reserve Bank will deliver a 50 basis point cut to the Official Cash Rate this week.

But with the RBNZ due to release a full monetary policy statement (2pm Wednesday), much of the attention will be focused on its new forecasts for the economy and where it is projecting the OCR to land next year.

ASB economists say the case for another sizeable cut remains almost as strong as it was in October. They describe it as the “least-regrets” path at present.

“With inflation back around the target mid-point and spare capacity starting to build up, the amount of monetary restraint needs to be quickly pared back. A 50bp cut would achieve that,” they say.

But a 75bp cut would likely overdo it given most of the recent developments have been in line with the RBNZ’s August economic outlook.

“The inflation outlook remains inherently uncertain with some upside external inflation risks potentially surfacing in 2025. We are sure the RBNZ is also mindful that it is about to go on a three-month policy holiday until the February MPS, which leaves less flexibility for the RBNZ to respond. And at 4.25% the RBNZ can be confident it won’t have overshot even if inflation suddenly looks like it is going back to its old tricks of being sticky. A 50bp cut best balances the various risks.”

At Capital Economics, senior economist Abhijit Surya argues that with inflation back at target, the labour market loosening rapidly and activity in the doldrums, “there continues to be a compelling case for the Bank to loosen policy aggressively”.

“With job vacancies continuing to slide, risks to the RBNZ’s current forecast for a peak unemployment rate of 5.4% remain tilted to the upside.”

For next week he also sees just a 50 basis point cut, noting the RBNZ has usually reserved 75bp cuts for full-blown crises, such as the GFC and the Covid-19 pandemic.

“Given that the ongoing downturn is much shallower, and has been entirely policy-induced, the committee is unlikely to feel the same sense of urgency,” he says.

“But regardless of the size of next week’s move, we still think the RBNZ will ultimately cut rates below neutral, so as to mitigate the risk of inflation undershooting its target over the medium term.”

“Given that the bank estimates the neutral rate at 3.4% over the forecast horizon, we are forecasting a terminal rate of 2.25%. That’s markedly lower than the analyst consensus of 3%, as well as the 3.25% trough currently priced into markets.”

Looking beyond the OCR move, KiwiBank chief economist Jarrod Kerr says he’s expecting to see the OCR track “pushed lower and pulled forward” given the RBNZ has delivered more cuts than they anticipated in August.

In other words, lower rates sooner - at least compared to their last outlook in August.

“The August OCR track implied 25bp moves, and we’re getting 50bp moves, as required. And then there’s the culmination of data that has come in weaker than the RBNZ’s already low forecasts,” Kerr said.

“Specifically, the inflation data for the September quarter saw headline inflation fall to 2.2% - which compared to the RBNZ’s August forecast of 2.3%, and May’s forecast of 3.0%. That’s some move … back towards the RBNZ’S targeted sweet spot of 2%.”

As for the RBNZ’s broader set of economic forecasts, KiwiBank expects to see a potentially faster turnaround in activity measures, particularly for economic growth estimates.

HSBC Australia and New Zealand chief economist Paul Bloxham said he expected the RBNZ’s board would consider cutting by 25bp, 50bp or 75bp this week “but will settle on a 50bp move, judging, in the end, that this would be the most prudent move that balances the risks to both growth and inflation”.

“We expect further cuts through 2025 but expect that the pace of easing will slow as the economy continues to recover. Our central case has one 25bp cut each quarter in 2025 to 3.25% by end-2025.”

Bloxham noted in its August monetary policy statement, the RBNZ indicated a neutral estimate of around 3.4% for the OCR.

The neutral rate is the level the central bank sees as the most likely default when economic conditions are in balance.

Bloxham also noted the next RBNZ meeting after this one is not for three months (February 19) because of the Christmas and summer break, twice as long as usual.

Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003.