Quarterly economic update - October 2022

Market recap

Interest rates have started to rise meaningfully as central banks try to rein in surging inflation by lifting official cash rates. Globally, 29 out of the 37 major central banks lifted cash rates in the three months to June – the highest proportion since 1992. The scale of monetary tightening in the US has led to mounting talk of a possible recession there in the first half of next year, with speculation further fuelled by two consecutive quarters of declining GDP growth in the US.¹

Locally, the Reserve Bank of New Zealand’s (RBNZ) hikes to the cash rate in the past 10 months – from 0.25% in October 2021 to 3% in August this year – are the most aggressive tightening cycle it has delivered since pioneering inflation targeting more than 30 years ago. The RBNZ has exceeded the rate rises of central banks in the US, Australia and Canada. The RBNZ Monetary Policy Committee in August lifted the official cash rate to 3% – a seven-year high.²

However, the consensus in the global market is that this sequence of very aggressive rate hikes has plateaued, leading to a recent bounce in share markets. The S&P 500 was up 9.1% in July, the benchmark index’s best monthly performance in nearly two years, while the NZX50 was up 6.9% in the same month.

Production is being constrained by acute labour shortages, heightened by seasonal illnesses such as cold and flu as well as COVID-19. Due to the tight labour market, NZ wages have risen at the fastest pace since 2008, says the RBNZ, and are set to further accelerate.

Inflation remains elevated

NZ inflation continues to outpace forecasts, climbing from 6.9% in March to 7.3% in June, a 32-year high.³

Households are facing hefty rises in the cost of food, petrol, and housing. Food prices are up 1.3%, with a 2.3% rise in transport, according to Stats NZ. ⁴

Housing and household utilities were the top contributors to both quarterly and annual inflation, with the main drivers being rent increases and an 18% jump in construction costs in the June 2022 quarter compared with same period last year.

Outlook – what’s expected next?

The cash rate is expected to continue to rise, with the RBNZ predicting a peak of 4.1% in March 2023 before it reduces in the second half of 2024.⁵ This will further increase pressure on borrowers but could lift interest rates on deposits for savers.

At the time of writing, economists are tipping a further 50 basis points increase in October and then an additional 25 basis point move in both November and February. The RBNZ Monetary Policy Committee says it remains appropriate to continue to tighten monetary conditions at pace “to maintain price stability and contribute to maximum sustainable employment”, and that “core consumer price inflation remains too high and labour resources remain scarce”.

Interest rate expectations are similar in other developed countries – the next US rate hike is expected to be between 50 and 75 basis points.⁶

Economists anticipate inflation will stay persistently and stubbornly at that higher level for a lot longer than people would want or expect. The current RBNZ forecast for inflation is a drop to 5.8% by the end of 2022, easing to 3.8% by the end of 2023. Inflation is not expected to return to the midpoint of the RBNZ’s 1-3% target band until mid-2024.

The general consensus among economists is that NZ is nearing peak inflation, but any consequent decline in prices will be slow. The RBNZ projects annual average economic growth of 2.8% in the year through to March 2023, slowing to 0.8% in the 12 months to March 2024.

As central banks around the world attempt to balance spiking inflation with softening economic growth, the risk of a hard landing and recession increases. Volatility in energy prices, due to the war in Ukraine, and labour shortages from COVID-19 are additional risk factors.

Most forecasters, however, predict only a moderate risk of recession. Goldman Sachs, for example, sees a 30-35% chance of a recession over the next 12 months.⁷

[1] Financial Times, ‘US economy shrinks for second consecutive quarter’, 29 July 2022, accessed 30 August 2022.

[2] The Straits Times, ‘New Zealand hikes interest rates another half-point to fight inflation’, 17 August 2022, accessed 30 August 2022.

[3] Stats NZ, ‘Annual inflation at 7.3 percent, 32-year high’, 18 July 2022, accessed 30 August 2022.

[4] Stats NZ, ‘Annual inflation at 7.3 percent, 32-year high’, 18 July 2022, accessed 30 August 2022.

[5] New Zealand Herald, ‘OCR: Reserve Bank hikes cash rate by 50bp’, 17 August 2022, accessed 30 August 2022.

[6] The Straits Times, ‘New Zealand hikes interest rates another half-point to fight inflation’, 17 August 2022, accessed 30 August 2022.

[7] The Straits Times, ‘New Zealand hikes interest rates another half-point to fight inflation’, 17 August 2022, accessed 30 August 2022.