In this all-Antipodean edition of Macro Minutes, Robert Thompson and Mary Jo Vergara discuss the RBNZ hiking the OCR rates for the first time in three years with more to come, in contrast to the RBA, which is stepping back into the shadows after three quick-fire hikes in February, March, and May.

Participants:

• Robert Thompson (Desk Strategy), Head of Australian Economics & Rates Strategy
• Mary Jo Vergara (Desk Strategy), Senior Economist

* Research Analyst opinions are their published views, independent of those expressed by Desk Analysts

Speaker 1: Hello, and welcome to Macro Minutes. During each episode, we’ll be joined by RBC Capital Markets experts to provide high-conviction insights on the latest developments in financial markets and the global economy. Please listen to the end of this recording for important disclosures.

Rob Thompson: Hello and welcome to an Antipodean edition of Macro Minutes. I’m Rob Thompson, Australian Head of Economics and Rates Strategy, and with me today is Mary Jo Vergara, our senior economist for Australia and New Zealand. We are recording this at midday Sydney time on the 15th of July. So we’ve just been through a quick-fire hiking cycle from the RBA. It took rates back to their post-COVID peak of 4.35% after three back-to-back hikes through Feb, March, and May. And now, we’ve just had a first hike from the RBNZ last week.

Mary Jo Vergara: Don’t remind me, Rob.

Rob Thompson: Now, they hiked for a much lower starting point of just 2.25%. This was their first in three years. So given Iran and renewed global inflationary fears, we’ve had plenty of other banks tightening again already, not just the Reserve Bank of Australia. MJ, what took the RBNZ so long to join the party?

Mary Jo Vergara: To join the party.

Rob Thompson: Not your expression.

Mary Jo Vergara: Yeah. Let me first apologize for how I was maybe on the day. I was probably not the most cheeriest of colleagues sitting next to you.

Rob Thompson: I’ve seen happier faces.

Rob Thompson: All right, so I’ll definitely strike all talk of a party from the record here. My apologies. I’ll try to ask things a different way then. Why did they switch so quickly from sounding happy enough to stay on hold in April to a split vote in May and then a consensus hike in July?

Mary Jo Vergara: It is interesting. It’s like meeting by meeting this year. They’ve shaken off their dovish feathers and grown some hawkish talons with every meeting. I think the decision itself to hike was not surprising. It was 80% priced going into the meeting. But the fact that it was a consensus hike was unexpected, I think, especially given the fact that there was really little data between the May and July meetings to fundamentally change their view. But I think what it is, it’s just the fact that during this conflict, as this conflict has been playing out, they’ve been sitting there with a stimulatory cash rate and they’re just uncomfortable with that at a time when inflation is already above target and will potentially move higher from there. They just don’t want monetary policy to be adding to any inflationary pressure. Basically, they want monetary policy to be one less reason that’s keeping inflation above 3%.

Rob Thompson: Okay, so you mentioned a stimulatory cash rate. How about broader financial conditions? Those were mentioned in the statement. How did that play into their thinking?

Mary Jo Vergara: It was. Yeah, there was a section dedicated to that. They’ve seen a recent easing in financial conditions, which is a key reason behind the hike. Rates in New Zealand are still higher than pre-conflict rates, but they had fallen back in recent weeks just with that global repricing after the MOU had been signed and expectations of central bank tightening had pared back a little bit, and Kiwi rates were following that move lower. The Kiwi dollar had also weakened in the weeks leading up to the meeting, so the MPC seemed pretty concerned about the implications that has for import inflation rising with a weaker currency. So it seems like the RBNZ is showing little tolerance to any and all upside risks to inflation. So I think there was an element of shoring up financial conditions, making sure that they stayed tight, as a reason for them to hike, to prevent a rallying rates that might’ve happened even if they delivered a hawkish hold instead.

Rob Thompson: I guess that makes sense, given what markets had priced in. Look, they obviously didn’t have this data in hand at the meeting itself. Subsequently, we’ve had a few pieces of strong information coming out, including that 10-point jump in the PMI. Also, a fairly strong performance of services come out post as well. Do you think the reaction, the further reaction to those indices is justified, given we had further sell-off in rates there?

Mary Jo Vergara: It’s good data. It shows that the recovery that was starting at the beginning of the year is resuming. So it’s good data, but I think that PMI jump was maybe more reflective of the resilience and overseas demand, particularly China, which is New Zealand’s largest trading partner. And that’s obviously been helped by a weaker Kiwi dollar. So I think it’s showing that if you look at more of the domestic indicators like the PSI, which is more of the services, that had also improved, but it’s not shooting the lights out like the PMI showed. And actually some card spending data, which came out recently as well, that declined over June. So that tells you, it paints this picture of a patchy recovery where, again, it’s this external-facing doing quite well. Internally, domestic demand is still quite weak and obviously hit by this conflict. So the data’s good. We’ll probably get that rebound in activity that’s expected over the third quarter. I just wish we had a little bit more time before they started normalizing policy. This recovery has been long forecasted, long awaited, and I just wish that we had more time to regain momentum before they started hiking rates. But markets, they’re taking the data as confirmation of further rate hikes from here, and it’s hard to argue against that.

Rob Thompson: Yeah. Okay. I mean, I could probably guess your answer to this question, but we’ll need to ask it anyway. Boiling this all down, would you say this hike was necessary or is there still a strong dovish case to be made?

Mary Jo Vergara: It’s necessary eventually. Again, like we said, the next move in the cash rate was always going to be up. It was just a difference in timing. And it’s classic RBNZ. Front footing is the strategy. And I can stand on my soapbox all day and say what they should be doing, but you have to play the institution, not the game. And they’ve made it clear that they don’t like the cash rate being below neutral, so that seems to be the path forward, is going back to neutral.

Rob Thompson: Okay. Well, I’m going to ask you to get back up on that soapbox and give us a formal take on where you think the OCR will be a year from now and how it differs from where it should be.

Mary Jo Vergara: Yeah. A year from now, I think those two might actually be one and the same. The cash rate will likely be at least 3%. Again, it’s charting back to neutral, which is 3%. I think the risks, though, are skewed to the upside, given that there is some discussion at RBNZ that the neutral cash rate maybe is higher than where they previously estimated it to be, which is around 3%. But I think the important point to make here is that in a year’s time, it should be going back to neutral. I think what they shouldn’t be doing is tightening policy. I think, as we’ve described, the domestic economy just, I think, would struggle with restrictive policy. Going back to neutral is something I can live with.

Rob Thompson: Okay. Even if you think the path there perhaps shouldn’t have been quite so fast.

Mary Jo Vergara: Yeah, maybe it just, again, it’s just waiting another couple of months to get that recovery momentum back. But yeah, we were all in agreement with where rates should be going. It’s just the timing issue. Okay, I’m getting sick of the sound of my own voice. Let’s move. Let’s fly three hours across the Tasman Sea and switch over to Australia. You said at the top of the show, Rob, that the RBA has almost taken a page out of the RBNZ’s book and have gone back to back to back 75 basis points of hikes and three straight moves. 4.35% cash rate. Do we reckon that’s terminal?

Rob Thompson: Look, at this stage, we’re thinking it is, but we started this podcast on New Zealand for a reason. RBA has been exciting so far this year through those three meetings, but now it feels like a bit more of a boring story where, as I said, 4.35% feels like terminal. The budget coming into the equation as well, putting a lot of negativity, particularly onto the housing front through those tax changes, has felt like a quasi rate hike added on top too. So no, we don’t think there’s going to be any more hiking, but on the flip side, can’t see any more cutting until well into next calendar year. It’s going to be a pretty boring story unless they are forced to hike again this year by inflation, which we think the odds for that are receding despite the flare-up of conflict in the Middle East recently.

Mary Jo Vergara: Yeah, I think because we initially, we had expected that maybe they go to 4.60%, but that budget has been quite the big change in everything. Like you said, it’s a good way of putting it, it’s a quasi hike in that it tightens conditions for RBA right?

Rob Thompson: It’s certainly surprised me, the reaction to the budget, just how large it’s ended up being. I mean, the changes were flagged heading in by the usual array of leaks pre-budget, and so we didn’t think it would have quite the sticker shock that it’s ended up having. Now, of course, house prices here are always very sensitive to these things, and they’ve moved a long way. But I guess it is more than that. It paints a bit of negativity into dwelling investment as well in general, and of course the whole consumption piece of the housing market is softer. Also, a bit of negativity overlaid on top of that as well. I mean, the rate hikes have been a bigger dampener earlier in the year, but that budget’s really taken over that narrative more than I would’ve thought heading in.

Mary Jo Vergara: Yeah. I mean, it wasn’t too long ago that markets were pricing in an RBA terminal of around 5%. The budget’s obviously been one reason why that’s been pulled back a little bit, but what’s taken markets from that to just 4.35%? And I think there’s about a half chance of one more hike this year.

Rob Thompson: Yeah, I think you’re right there. I think, having jumped the gun before, the budget’s probably the main reason, which took away from our initial forecast that they’d have to hike to 4.6%. But of course, in the background, we’ve had those Middle Eastern oil fears recede, notwithstanding the last couple of weeks of additional volatility and shutdown of the strait and so on. But look, back to the impact of those three hikes we’ve had already, which, of course, is unwinding the cuts we had last year. The cumulative impact of those on financial conditions more broadly, and, of course, we’re very sensitive to that cashflow channel having the vast majority of our mortgages being floating rate certainly has come through. Growth’s been a little bit on the softer side lately. And then just that federal budget piece has really come in and given us the final straw, if you like, preventing the need for anything further. In terms of the hiking, we’ve still got priced into the curve, which it’s oscillated a little bit again on oil prices and so on recently, but I think the market is really struggling to price a whole lot more than around a half chance at most or maybe 15 basis points of hikes the rest of this year. Given we are now back to the previous post-COVID peak in the cash rate with everything else hanging over us, it just doesn’t feel like the market can get anywhere near that 5% it was at peak uncertainty.

Mary Jo Vergara: Yeah. We get the sense now that the focus is turning now to how many cuts we can price for the RBA over next year. What do you think is the earliest we can reasonably expect for an easing cycle to emerge? You said not till the back end of next year. And how many cuts do you think the market can factor in?

Mary Jo Vergara: Yeah.

Rob Thompson: All right. Thanks, everyone, for listening in. We’ll leave it there for today’s edition, but we look forward to our next installment. And I’m sure there’ll be plenty of other Macro Minutes content from the rest of our global strategy team in between.

Speaker 4: This content is based on information available at the time it was recorded and is for informational purposes only. It is not an offer to buy or sell or a solicitation, and no recommendations are implied. It is outside the scope of this communication to consider whether it is suitable for you and your financial objectives.