In our first episode of Bridge talks Business, Ryan talks with Milford Investment Analyst Katlyn Parker about anticipated interest rate cuts. When is the RBNZ likely to start cutting rates, and could this cause inflation? And what are the implications to our economy – will this cushion the blow to deliver a soft landing?

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Bridge talks Business: 13 August 2024
Episode Transcript

Ryan Bridge
Kia ora and welcome to episode one of Bridge talks Business with Milford. I’m Ryan Bridge and I’m here to talk business, obviously. Every week I’ll be right here doing just that, wrapping the major market movements and going behind the headlines with Milford’s team of analysts and experts. Right now, it is time for the top five business bits you need to know from the last seven days.

#1. Stability returns. After panic hit global markets, most have now recovered and are largely unchanged, including the NZX 50. #2 Unemployment is up. The data out last week wasn’t as bad as many anticipated, with the rate jumping from 4.3 to 4.6%. More on what that means for interest rates in a second. #3 Over the ditch, the Reserve Bank of Australia kept interest rates steady, but a warning they could hike if conditions are warranted – yes, hike. Potentially inflation at 3.8% still outside the target range. #4 We’re watching retail sales and inflation data in the US closely. Investors there are nervous about a slowdown in the world’s largest economy. #5 It’s the OCR obviously, and what we need right now is some analysis.

Not only were we one of the first, but also one of the most aggressive in hiking interest rates to try and smack down runaway inflation, but now our Reserve Bank, along with central banks around the world, are either starting or close to slashing those very same rates. So why now? And could our slide down the interest rate track be as steep as our ascent? Firstly, some housekeeping. Everything we talk about here is informational only and should not be considered financial advice.

I’m delighted to be joined by Katlyn Parker, Milford Investment Analyst for episode one. Welcome.

Katlyn Parker
Thank you.

Ryan Bridge
Let’s talk about the rates. Why now? Why are we looking at changes? Why are we able to go down?

Katlyn Parker
Now look, inflation is falling and central banks around the world are getting confidence that inflation is on the way down. But we’re definitely seeing massive divergences across economies, and different economies are going to have different outcomes. So, I do agree that we’re definitely seeing this pivot from central banks towards a rate cutting cycle, but on varying schedules. So you know, Bank of England, European Central Bank, they’ve started to cut interest rates. Our neighbours in Australia, they remain firmly on hold, and like you said in New Zealand, we were the first to hike. So, the market’s actually calling that we should be cutting right away, and in the last meeting that we had with the RBNZ, we definitely saw a pivot from them from taking a rate hike off the table to, you know, showing their hands that the next move will be a cut in interest rates from here.

Ryan Bridge
We’ve so far managed to avoid a hard – what they call a hard landing – in the economy. Can we avoid it if we start cutting now?

Katlyn Parker
Yeah. Look, so if we think of a soft landing, a soft landing is essentially a relatively painless slowing in economic growth. And like you said, we have avoided that hard landing, where everything comes crashing down at once. But I’m not taking away from there’s definitely been pain in the economy. We have had technical recessions. But if we look at, you know, the pressures they’re really mounting right now. So right now, we haven’t had a hard landing. But the risks are definitely pointing towards a worsening economy, so we have unemployment is increasing, we have migration is slowing, we’re seeing a mass exodus of Kiwis over to Australia. The housing market is muted. You know our productivity is weak, growth is negative. And then also if we look externally, you know the US is showing a lot of signs of slow down, and also China seem very reluctant to stimulate their economy. So in New Zealand there’s a real risk that the RBNZ  has actually been too late to come to the table to start cutting rates, or that they actually just delivered too little.

Ryan Bridge
Cause what is that time lag to give people a sense? If you start cutting now, how long does it take before it’s actually felt.

Katlyn Parker
You know, they say three, six months in terms, but also the data that we get is so backward looking. So, when we spoke about how we haven’t had a hard landing, we’re looking at data for earlier in the year in terms of the unemployment data and when we get inflation, it’s very limited in terms of the real time data that we have and that the RBNZ will be looking at.

Ryan Bridge
Do we know how the economy will respond? Because we’re coming from quite elevated levels in terms of the OCR, right?

Katlyn Parker
Yeah. So we’re not going to find out overnight. If the RBNZ do deliver a rate cut at the next meeting, we’re not going to see an impact overnight or in the short term. So, we want to be looking out three, six months and like you say, we’re not going to get that instant relief because we are starting from a historical high level of interest rates. But best case scenario, what we want to see – we want to see productivity increasing. We want to see business confidence rebounding, consumer confidence on the way up. And we’d also want to see an uplift in demand, but not at a pace that would have a risk of inflation becoming renewed.

Ryan Bridge
It’s interesting because you’ve got to feel for the Reserve Bank on one sense, because you’re balancing all of those things that sound so bad, and they are, with not wanting to let inflation run away again, right?

Katlyn Parker
Yeah. And that’s their sole mandate now is to achieve price stability. So, it is a main focus – and one of the reasons that they haven’t started cutting already is because of this inflationary risk. So it is worth noting it’s not a base case that inflation is going to skyrocket again if cuts are delivered. But it is worth noting that rate cuts can unleash some pent up demand, and it’s not just here in New Zealand, that’s also a risk globally for those developed economies that are starting to cut interest rates. But in New Zealand, you know households have over the last year or so been locking in short term mortgages. So, only fixing for 6-12 months, so that transmission from rate cuts to households is actually going to be pretty swift, versus if we think back to during Covid, when rates started to increase, households had, rightly so, taken advantage of those ultra low, you know, two to three-year mortgage rates. So, it was quite slow to see that transmission of higher rates actually hitting household’s pockets.

Ryan Bridge
The come down is going to be quicker because people are on shorter – they’ve fixed for six months or whatever.

Katlyn Parker
Exactly. So they’re going to get the benefit of a lower rate coming through, albeit it’s still going to be a pretty high rate and nowhere near the lows of Covid that they were fortunate to lock in.

Ryan Bridge
Yeah, I think we all have grand visions of what it’s going to look like. The reality might be something different.

Katlyn Parker
Yeah.

Ryan Bridge
What about house prices? How will it potentially impact house prices? You know, given that rates will come down, money will become cheaper. Potentially people can afford to pay more.

Katlyn Parker
I think first of all we just talk about mortgage rates. So they’re obviously a big factor in terms of what will happen with house prices. So, yes the lower trajectory for the Official Cash Rate, that’s one component that will go into how your bank will calculate your mortgage rate. But banks have been benefiting from cheaper funding via the Funding for Lending programme, and that’s starting to roll off. So they’re going to have to be paying for higher funding – so term deposits and the like. So, they’re going to have to pay up for this funding versus what they have been getting over the past couple of years – so that potentially could see pressure on the margins that are applied to those wholesale rates for your mortgages. But then number two, we need to see what’s going to happen in terms of lending to the housing market, because it has been pretty slow, and mortgage rates are still going to be pretty elevated for a lot of people. So, if lending is pretty slow, you could see banks starting a bit of a mortgage war and competition really hitting up in that sector. So that’s kind of one thing to be aware of for your mortgage, right. But then in terms of house prices, you know, people are saying you’re going to see a lot of buyers coming back to the market when rates start to come through, and definitely I agree with that. But also on the other hand, you’re probably going to have a lot of people put their houses on the market. So, supply could actually overwhelm the demand. But again, with house prices, we’re just going to have to wait and see how it does transpire.

Ryan Bridge
Yeah. OK, you got me a little bit excited there talking about the potential for a war between banks on interest rates. But we won’t get too excited just yet. There’s a lot of water to go under the bridge before any of that happens. Just sum up for us, Katlyn, where we are. How fine a tightrope walk is the Reserve Bank having to do here in the economy. And as you’ve mentioned, economies around the world are in this position. You’re not wanting to push your economies into recession, but you’re also wanting to make sure that you have extinguished that fire that is inflation.

Katlyn Parker
Exactly. And it’s a very, very hard thing to do. I saw someone describe delivering a soft landing once as trying to land a plane on a treadmill. So, if you actually think about it, you know that is what they are trying to do. And we also need to look at what the market is expecting the RBNZ to do. And as it stands, the market is expecting close to a percent in cuts before the end of the year. So, you know, if the RBNZ do deliver a cut at the next meeting or if they deliver a bigger cut later on in the year, it’s going to be very, very hard for them to actually match the amount of cuts that the market is expecting at this time.

Ryan Bridge
How much attention should we pay to the language around the decision itself? Cause we’ll hear a lot about the decision obviously, but the language that’s used around looking forward to potential for cuts in the future.

Katlyn Parker
Hugely. So, one of the really important things to look out for is the track that the Reserve Bank will publish. So, that’s where they see the Official Cash Rate going over the next period, next year, and into 2026. So, there will be a huge focus on that. But right now the market is expecting, you know, 2.3% in terms of cuts to happen between now and November of next year. So it’s going to be very, very hard to see the Reserve Bank lowering their track by that much to meet those market expectations.

Ryan Bridge
Katlyn, thank you so much for being with me.

Katlyn Parker
Thanks for having me.

Ryan Bridge
Great to have you as my first guest.

Katlyn Parker
Honour.

Ryan Bridge
That is Katlyn Parker, Investment Analyst with Milford. And that is it for episode one. Thank you so much for watching, like, subscribe, do whatever you gotta do, wherever you gotta do it, we’ll be back next week.