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Westpac economist suggests weak local economy and overseas banking turbulence mean RBNZ may end OCR hiking cycle in April


By Dan Brunskill

Traders and economists are paring back expectations for how high interest rates will go after the spectacular collapse of Silicon Valley Bank and weak economic activity in December.

Just weeks ago, forecasters were mostly onboard with the Reserve Bank’s projections that it would lift the Official Cash Rate (OCR) another 75 basis points across its next three meetings.

Now, some think a 25 point increase in April will be the last of this cycle as the local economy teeters on the edge of recession and overseas regulators stabilise a handful of troubled banks.

The Reserve Bank (RBNZ) last month increased the OCR 50 basis points to 4.75%. It's now up 450 basis points since the current hiking cycle began in October 2021. In its February Monetary Policy Statement the RBNZ had the OCR peaking at 5.50% by December this year. The next OCR review is April 5.

Westpac NZ radically lowered its OCR forecast on Thursday, after being surprised by data showing weak economic activity in the last three months of 2022.

Acting chief economist Michael Gordon said the gross domestic product figure was a “major surprise to our understanding of the state of the economy”.

“The 0.6% drop in activity was weaker than both we and the market expected, and even more so once we take into account the downward revisions to growth in the previous quarters”.

This means economic activity was almost 2% weaker than the RBNZ thought when it released projections in February, and shouldn’t require as much restriction to bring inflation under control.

“We suspect that the December quarter was more of an air pocket during our descent, rather than an earlier and harder landing than the RBNZ was aiming for. Even so, the RBNZ will need to adjust its flight path accordingly”.

Gordon said the data prompted the Westpac research team to revise its cash rate peak to 5%, down from 5.5% previously.

“That implies only one more 25 basis point increase left in this cycle, which we still think will be delivered at the April OCR review”.

The April review doesn’t come with new forecasts or interest rate projections, meaning the central bank will be unlikely to reveal whether it has finished hiking until its meeting in May.

Traders had priced an OCR peak of 5.2% into overnight swap rates on Friday, down from 5.6% at the start of this week, suggesting serious doubts about future hikes.

Banked turn

Another reason financial markets have rapidly revised expectations has been the failure of Silicon Valley Bank - the 16th largest bank in the United States.

It collapsed largely due to the fast pace of interest rate increases, for which it had not hedged, which damaged the market value of the bonds it had been investing deposits into.

Some commentators think the US Federal Reserve continuing to raise rates would hinder its simultaneous efforts to restore confidence in the banking system.

Capital Economics, a macroeconomics analytics company, said in a note that bank failures such as Silicon Valley Bank were a warning that things can break when rates move too fast.

“This argues for policy makers moving more gradually on tightening from here,” it said.

Reuters reports US banks sought record amounts of emergency liquidity from the Federal Reserve over recent days following the failures of Silicon Valley Bank and Signature Bank. Banks took US$152.9 billion from the Fed's traditional lender-of-last resort facility known as the discount window, plus US$11.9 billion in loans from the Fed's newly created Bank Term Lending Program. The most taken from the discount window previously was US$112 billion in the autumn of 2008, Reuters says.

On Monday, US traders had priced in a Fed Funds Rate increase of about 70 basis points in the coming months. That has now almost halved to just 39 basis points.

ANZ Bank chief economist Sharon Zoller said NZ’s lower swap rates were largely following the declines in the US market.

“The correlation between daily rate moves in the US and NZ has long been higher than any macroeconomic links could justify,” she said in an email.

Several economists told that traders were overestimating the monetary policy impacts of Silicon Valley Bank’s collapse in NZ, which has been broadly unaffected.

At the margin, the reminder that the global environment was volatile and risky might push the RBNZ towards a smaller rate hike - but was unlikely to put them off altogether.

“I don’t think it will be an easy decision to make, or for those of us on the outside to predict. But as Adrian Orr once said, if OCR moves are a no-brainer, then clearly rates are not where they need to be,” Zollner said.

ANZ economists have held onto their OCR forecast of two 25 basis points hikes in April and May to reach a peak of 5.25%. However, Zollner warned it was possible for inflation to linger and the OCR could end the year nearer to 6%.

BNZ’s research team has the same official forecast but senior economist Craig Ebert said the balance of risk was starting to shift to an even lesser peak.

“The recent warning signs from the international financial sector play to this - to the extent they suggest lower inflation pressure ahead, that is”.

Holding the OCR at 5% would provide some relief for mortgage payers, and could inject some confidence into the gloomy housing and equity markets.

This story was originally published on and has been republished here with permission.