As the Reserve Bank of New Zealand (RBNZ) approaches its final monetary policy meeting for 2024, calls grow for a more aggressive approach to interest rate cuts.  With the next meeting not scheduled until February 19th – an unusually long gap of almost three months – some analysts argue the central bank should opt for a bold 75-basis point reduction over the widely expected 50-point cut.

The timing of this decision is crucial.  Like a tramper facing a two-day journey to the next hut instead of the usual day's walk, the RBNZ needs to consider whether to pack extra provisions – i.e. a larger rate cut – to weather potential economic storms during the extended period between meetings.

The economic backdrop has become increasingly concerning.  A group of 15 prominent economists, led by former Productivity Commission chair Ganesh Nana, has warned about the compounding effects of government spending cuts on monetary policy tightening.

In a letter to the Prime Minister, they argued that the cancellation of key infrastructure projects and public service reductions are "substantially worsening" the contractionary effects of the RBNZ's monetary policy stance.[i]   This warning comes as unemployment reached 4.8% in the September quarter, with the RBNZ forecasting it to peak at 5.4%.

The job market deterioration is evident in recent announcements, including over 200 jobs under threat at Tokoroa's Kinleith Mill, highlighting the spreading impact of economic weakness across regions and sectors.[ii]

Greg Smith of Devon Funds, a vocal advocate for more aggressive monetary easing, points to what he describes as "dire" economic data.   "The economy is in recession, and unemployment is on the rise," Smith notes, highlighting weakness in both manufacturing and services sectors.[iii]

The case for a larger cut is bolstered by several key factors:

1.      Domestic inflation remains a challenge

Inflation has now fallen back within the RBNZ's target band of 1-3 percent, with some projections suggesting it could even undershoot the desired midpoint of 2 percent.

However, beneath the headline figures lies a more complex picture – while global inflation is trending lower, domestic inflation remains stubbornly high, creating a challenging environment for policymakers.

2.      The OCR remains uncomfortably above neutral

The current OCR at 4.75 percent remains well above what the RBNZ considers its "neutral" rate of 3.8 percent – the level at which monetary policy neither stimulates nor restricts economic growth.

With the economy showing clear signs of stress, there's a strong argument for moving more quickly toward this neutral stance.

3.      Global economic uncertainties pose a pressure risk

The international context adds another layer of complexity.  China, New Zealand's largest trading partner, continues to face economic uncertainties, creating what Smith describes as "flashing red lights" for the export sector.

These external pressures could further weigh on New Zealand's economic recovery during the lengthy gap between monetary policy meetings.

 

The impact on ‘business as usual’ for Kiwis

For term deposit holders, the current environment presents particularly challenging circumstances.  The negative yield curve (shorter-term interest rates are higher than longer-term rates) creates a significant dilemma for savers.

After accounting for tax and inflation, real returns on term deposits are proving especially tough, making cash flow planning increasingly difficult for those relying on interest income.

Financial advisers are increasingly emphasising the importance of diversification beyond just term deposits.  This unusual market dynamic underscores the importance of having a well-thought-out financial plan and seeking professional advice.

For households and businesses, the stakes are significant.  Many firms are reportedly struggling, with some "on the brink of failure" having exhausted their cash reserves and bank funding lines, according to anecdotal evidence and recent banking sector comments.

The wave of business redundancies continues week by week, suggesting that a larger rate cut before Christmas could provide crucial relief during a traditionally challenging period for business cash flow.  (Think the post-holiday tax obligations with two GST payments in 6 weeks – 15thJanuary and 28th February).[iv]

However, not all analysts support this aggressive approach.  BNZ's head of research, Stephen Toplis, while acknowledging the need for continued easing, argues that drastic measures aren't necessary.  He points out the RBNZ has already cut rates more than initially planned, suggesting that a measured approach remains appropriate.  ASB Senior Economist Mark Smith similarly advocates for a more gradual path, projecting a "more measured pace of OCR easing over 2025" with an eventual 3.25 percent achieved by late next year.

The financial markets currently price an 88 percent probability of a 50-point cut and a 12 percent chance of a 75-point reduction, suggesting that while a larger cut remains a minority view, it's not entirely out of the question.

 

For now, we wait (and plan)

The RBNZ's decision, due at 2:00pm next Wednesday 27th, will need to balance multiple factors: the clear evidence of economic weakness, the extended gap until subsequent meeting, the progress made in containing inflation, and the risk of moving too aggressively and potentially having to reverse course later.

Like that cautious tramper planning for a longer journey between huts, the RBNZ needs to carefully consider whether its standard provisions will be sufficient for the extended journey ahead, particularly given the compounding effects of fiscal and monetary tightening. [v] [vi] [vii]

For investors and savers, the message is equally clear: in these uncertain times, having a well-diversified portfolio, a well-considered financial plan, and the counsel of a qualified financial adviser has never been more important.

A well-balanced portfolio including a mix of assets can help protect against the erosion of purchasing power that purely cash-based savers are experiencing in the current high domestic inflation environment.

 

Nick Stewart (Ngāi Tahu, Ngāti Huirapa, Ngāti Māmoe, Ngāti Waitaha) is a Financial Adviser and CEO at Stewart Group, a Hawke's Bay-based CEFEX & BCorp certified financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver scheme solutions. Article no. 382.

The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from a Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz

 

[i] https://businessdesk.co.nz/article/economy/spending-cuts-hurting-growth-prospects-says-group-of-economists

 

[ii] Over 200 jobs under threat at Tokoroa's Kinleith Mill

 

[iii] https://www.nzherald.co.nz/business/75-point-ocr-cut-needed-to-aid-economy-stuck-in-rut-fund-manager-says/4TZ2A25PFVAUFOU3JMHTM3OUIU/#:~:text=Like%20a%20dog%20with%20a,are%20in%20such%20circumstances%20now.%E2%80%9D

 

[iv] https://forwardaccounting.co.nz/be-canny-with-cash-flow/

[v] https://www.rnz.co.nz/news/national/531516/jumbo-sized-75-point-ocr-cut-possible-november-experts

 

[vi] https://www.interest.co.nz/economy/130352/bnz-economists-look-back-some-reasons-why-reserve-bank-made-big-ocr-cuts-past-and

[vii] https://businessdesk.co.nz/article/economy/no-respite-for-nzd-as-rbnz-set-to-cut-cash-rate-by-50bps