The Reserve Bank of New Zealand is expected to remain on its rate hike path on Wednesday when it announces its latest policy decision at 02:00 GMT. A 50 basis point rate hike is fully priced in by the markets, so investors will be on the lookout for any changes in the rate outlook amid all the rumors of a recession. No press conference is scheduled for the July meeting and the RBNZ will not release any new forecasts. The focus will therefore be entirely on the language of the declaration. Any clue to the future path of rates could be significant for the local dollar.
Growth prospects diminish
After pushing up the official cash rate (OCR) consecutively at every meeting since October last year, borrowing costs in New Zealand have already reached what the RBNZ considers a neutral level at 2.0% . The neutral interest rate is the level considered to be neither contractionary nor expansionary for the economy. But as fears of a global recession rage, is the risk of a recession more pronounced in New Zealand?
After an initial rapid and robust recovery from the pandemic, New Zealand’s economic growth has stalled since the second half of 2021. GDP unexpectedly declined by 0.2% q/q in the first three months of the year, mainly due to Omicron and lower exports, and although a rebound is likely in the second quarter, the outlook for the rest of 2022 is dim.
Business confidence has plunged
Aggressive monetary policy tightening by the RBNZ, soaring inflation and weakening demand from New Zealand’s major trading partners, such as China, are weighing on business confidence. The NZIER Business Confidence Index – a closely watched gauge – fell in the second quarter to the lowest since the peak of the pandemic crisis in 2020.
But as companies face rising interest rates at a time when energy and other input costs are skyrocketing and global demand is collapsing, the biggest impact of the flash tightening RBNZ has been on the housing sector. The combined fiscal and monetary stimulus that was launched to support the economy during the shutdowns fueled an already hot housing market. But now that the stimulus has been withdrawn and the RBNZ is about to push rates into restrictive territory, house prices are falling.
A slowdown in the housing market
While it is true that New Zealand is suffering from a housing shortage and this will likely put a floor under prices at some point, the enormous size of the housing bubble means that the correction could still be quite steep. If house prices do not stabilize quickly, the effect of declining household wealth could further undermine consumer confidence. A measure of consumer confidence by a Westpac survey fell to an all-time low in the second quarter as households felt pressure from soaring living costs.
The deterioration of the context has led investors to lower their expectations regarding the evolution of rates, cutting around 50 basis points from the futures markets. The question is, are RBNZ policymakers also rethinking?
RBNZ considering further rate hikes
At its last meeting in May, the RBNZ predicted that the spot rate would peak earlier but at a higher level, forecasting a terminal rate of 3.95%. But before the latest price review, investors were even more aggressive in their expectations and the market’s current implied path is now much better aligned with the RBNZ’s own guidance. Therefore, the impact of all of this on the New Zealand Dollar was minimal, and the currency traded mostly on global risk sentiment.
With inflation hitting a three-decade high of 6.9% in the first quarter, the RBNZ is unlikely to look more cautious just yet, even if the economy could enter a major storm. The next quarterly CPI data is due July 18 and this may well have ramifications for the August policy decision.
Kiwi looks vulnerable after falling to $0.61
But for Wednesday’s meeting, the bank is very likely to raise rates by 50 basis points for the third time and maintain its hawkish tone. This could help the kiwi stabilize above the $0.61 level, which it tested today for the first time in two years. If a hawkish statement coincides with an improvement in risk appetite, the kiwi could recover above the $0.62 handle. However, a rally towards the neutral setting of the 50-day moving average located slightly below the 61.8% Fibonacci retracement of the May-June rise at $0.6352 seems a long way off.
In the event, however, that the RBNZ cites high downside risks to growth, markets could interpret this as a dovish tilt. Renewed selling pressure could send the kiwi lower to the 161.8% Fibonacci extension of $0.5989 before the bears turn to the 200% Fibonacci of $0.5850.