New Zealand cuts policy rate for first time in four years

The Reserve Bank of New Zealand (RBNZ) cut its policy rate today (August 14) for the first time since March 2020, amid falling inflation and weakening economic activity.

The bank’s seven-member monetary policy committee (MPC) decided to cut the official cash rate by 25 basis points to 5.25%. It had previously raised the rate by a total of 525bp, from 0.25%, since October 2021.

In a statement, the RBNZ said the pace of further easing would depend on “the committee’s confidence that pricing behaviour remains consistent with a low-inflation environment, and that inflation expectations are anchored around the 2% target”.

The bank has an inflation target of between 1% and 3% over the medium term, with a focus on keeping future price rises near the 2% midpoint. New Zealand’s consumer price index rose 3.3% year on year in Q2, having eased from 4% in the previous quarter and a recent peak of 7.3% in Q2 2022.

The bank said it expected consumer price inflation to return to the 1–3% band in Q3 and remain near the mid-point “over the foreseeable future”.

It said surveyed inflation expectations, firms’ pricing behaviour and headline inflation were all moving in a manner consistent with low and stable inflation.

The central bank added that although services inflation remains elevated, it expects it to continue to decline, both domestically and abroad.

The rate cut came almost a year ahead of the RBNZ’s own projections and will have taken many analysts by surprise. Nineteen of the 31 analysts polled last week by Reuters expected the bank to hold the policy rate, while the remainder correctly predicted a 25bp cut.

The RBNZ’s latest forward guidance suggests at least three further cuts by the middle of next year, projecting the cash rate at 4.9% in Q4 2024 and 4.4% in Q2 2025. The bank had not previously expected to start cutting rates until the middle of next year.

New Zealand joins other central banks that are starting to ease monetary policy. The European Central Bank and the central banks of Canada, Sweden and Switzerland have all cut rates in recent months.

“Although the bank appeared to strike a cautious tone about further policy easing, we think it will cut rates more aggressively than many are anticipating,” Abhijit Surya, economist at Capital Economics, said in a note.

He noted that in recent years the RBNZ had tended to cut rates more rapidly than it had signalled at the start of an easing cycle.

Weak domestic activity

New Zealand edged out of recession in Q1, when GDP grew by 0.2% on the previous quarter. The economy had contracted over the two previous quarters.

However, in its August monetary policy statement, released today, the RBNZ said recent indicators suggested GDP had contracted during Q2.

The bank said the weakening in domestic economic activity observed in July had become “more pronounced and broad-based” and that it now expected GDP to decline further in Q3.

In a summary of the discussions at the MPC meeting, policy-makers observed that the balance of risks had “progressively shifted” since their assessment in May.

“With a broad range of indicators suggesting the economy is contracting faster than anticipated, the downside risks to output and employment that were highlighted in July have become more apparent,” the records show.

They noted that a range of high-frequency indicators pointed to a material weakening in domestic economic activity in recent months. These included various survey measures of business activity, electronic card transactions, vehicle traffic, house sales, filled jobs and job vacancies.

The MPC assessed the output gap to be worse than it had assumed in May, indicating increased spare capacity. The summary also said that recent data suggested employment growth had slowed, with declines in private sector jobs, hours worked and wage growth. The committee members expected employment growth to further weaken over the coming quarters because of a fall in government spending and public sector job losses.

The policy-makers said the current restrictive monetary policy and tighter fiscal policy could be constraining domestic demand. They added that falling net migration might also be playing a role in the current economic weakness.

They also noted that below-trend growth was being observed across advanced economies. Central banks in some of these economies had begun cutting rates, the policy-makers added, to reflect lower core inflation, weaker activity and softer labour markets.

“In this respect, New Zealand’s economic activity and near-term inflation indicators now resemble those in countries in which central banks have started cutting policy rates,” they said.

The MPC warned that a weaker global economy, and particularly developments in China, could dampen demand for New Zealand exports and reduce exporters’ earnings, but that more subdued global demand could also lead to lower import prices.

However, the policy-makers added that ongoing geopolitical and trade tensions and the global reshoring of manufacturing could lead to higher import prices for New Zealand.