Inside Economics: Rate cut next week? Economists call for Reserve Bank to move now
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Does the market meltdown change the game for RBNZ?
The global sharemarket meltdown across the past week might have made things easier for the Reserve Bank.
While markets have been betting on an August rate cut for some weeks it never looked like a realistic prospect - until now.
Whether it moved in August, October, or November, the RBNZ always had a huge pivot in front of it. RBNZ’s official rate track (released in May) still has its first rate cut pencilled in for August next year.
Unlike market economists, central banks don’t get to update these things whenever they see fit.
But, just to be clear, the current debate is about whether they’ll cut the OCR this August. That’s this August, the one we’re in now! It’s next Wednesday at 2pm to be precise.
So it’s a very big leap.
Until all the market turmoil unfolded I figured that leap between a forecast August 2025 cut and an actual cut in August 2024 was too big to make.
It may still be. But there is now a dramatic turn of events of events that the RBNZ can point to for the pivot. How dramatic is hard to say (especially when you’re writing to a deadline ahead of Wall Street’s opening).
It’s likely markets will be volatile for a while even if they rally short term. The risk of further investor panic remains very real.
Yesterday both BNZ and Kiwibank economists piled pressure on the RBNZ by calling for an August cut. To be fair both BNZ and Kiwibank had already been arguing that we are overdue for a cut.
But the latest calls were more forceful.
“Overly restrictive monetary policy has inflicted much pain and tamed the inflation beast. Households and businesses are struggling,” wrote Kiwibank chief economist Jarrod Kerr.
“Almost all data have come out on the weaker side of expectations, and well below RBNZ estimates. Unemployment is rising, swiftly, and confidence in the economy remains at recessionary levels. It’s been two years of recession. Interest rate relief is required, now.”
Kerr described the RBNZ’s hawkish monetary policy statement in May as “a massive misstep in the wrong direction”.
“We recommend a cut next week, followed by a cut at every meeting until the cash rates hit 2.5%,” Kerr said.
BNZ head of research Stephen Toplis also called for “an immediate rate cut”.
“We strongly believe the Reserve Bank should be easing monetary policy as soon as possible. Indeed, we are on record as having said that it should already have done so,” he said.
“Given the lags between rate moves and their impact on the economy and the current parlous state of New Zealand, we strongly advocate that the Bank starts a progressive easing cycle from the August meeting.”
Will RBNZ cut though?
Neither Kerr nor Toplis is confident that the RBNZ will actually cut next week even though markets have it nearly fully priced in.
Kerr notes that market odds are now at 92% priced (as of Tuesday).
“And there is nearly 220bps of cuts priced to August next year (3.32%). The terminal rate has collapsed from 4% a few weeks back, to 2.95% today.”
Just before the big Asian market sell-off on Monday afternoon, Westpac economists brought forward their expectation for the first OCR cut to October and said they expected to see a second one in November.
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“Recent data suggest that economic activity dipped more sharply than previously expected in the June quarter of 2024. This is evident in a raft of higher frequency indicators such as business and consumer confidence and the Purchasing Manager Indices.
“We think that GDP fell 0.6% in the June quarter. Given this weak performance, it looks likely that growth will continue to be subdued in the second half of 2024.
“Importantly, we now also see definitive signs that the labour market is adjusting more quickly to the weak growth profile that has been in place for some time. We now expect the unemployment rate to move more quickly to a higher peak of 5.6% in 2025.”
That’s bad news really - however much mortgage holders might be cheering for lower rates.
We probably shouldn’t lose sight of the fact that all this rate-cut talk is underpinned by fears about the state of the economy both here and around the world.
On that basis, I hope Westpac is right. A cut next week would be nice for mortgage holders. But getting there would likely require a horrible week for the global economy.
Did the Fed wait too long?
This week’s sell-off has certainly locked in a September rate cut for the US Federal Reserve. There is no shortage of financial commentators saying the Fed blew it by not moving last week.
Some have even suggested an emergency cut will be needed sooner than September. That’s possible if the sell-off keeps spiralling but also risks adding to the panic.
Whether the economic outlook in the United States has really changed that much in a week is debatable. Economist and New York Times columnist Paul Krugman reckons recessionary warning lights are flashing.
“The US probably (probably) hasn’t entered a recession yet. But the economy is definitely looking pre-recessionary,” he wrote on Tuesday.
“It’s already clear that the Fed made a mistake by not cutting rates last week; indeed, it probably should have begun cutting months ago. Unfortunately, we can’t turn back the clock. But the Fed’s open market committee, which sets short-term interest rates, can and should make a substantial cut — probably half a percentage point, rather than its usual quarter-point — at its next meeting, scheduled for mid-September.”
How significant is the market sell-off really? We won’t know for a few days yet.
But you could make the case that Wall Street investors just ran out of patience and threw a collective tantrum.
Unlike 1987 and 2008 there is little mystery to the underlying causes of this correction. Investors have been on edge for some time about the prospect of the Fed winning the inflation fight without causing a recession.
Meanwhile, they’ve been piling into tech stocks on AI hype creating a precarious bubble in parts of the market. That combination created a tinder-dry bonfire that just needed a spark.
It got two.
A worse-than-expected US jobs report on Friday set recession fears alight. Meanwhile, a specific shift in the economic outlook for Japan saw a huge move in investor sentiment and caused the biggest one-day fall the Nikkei had seen since 1987.
It could have been worse. And of course, it might still be. There was really no way around a correction for tech stocks on the Nasdaq. But if we can get through that without the whole system crashing down then lower rates should start to buoy the rest of the market.
Here’s hoping.
Between the start of 2023 and their peak in June, shares in AI chip maker Nvidia rose by 740%. That kind of puts the 20% they’ve slumped in past two months into perspective.
It’s a reminder that unless you’re a trader it pays to take a long view of investing. Unless you are betting on the fall of modern civilisation then there is no reason to bet against markets. They consistently create wealth for investors. Just have a look at a graph of the S&P500 across 30 years (see below).
Look at the starting point, look at the endpoint, and rule an imaginary line between the two. That’s what most of us should be focused on. If you are a share trader, that’s different. But as Warren Buffett said this week: if you’re afraid of a market sell-off, you shouldn’t be trading shares.
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