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Start of easing cycle has turned market attention to likely size of further cuts

The bond market has turned its attention to the likely size of further interest rate reductions now that the Reserve Bank of New Zealand (RBNZ) has made two cuts to the Official Cash Rate (OCR) in quick succession. After keeping the OCR at the elevated level of 5.5% since May 2023, the RBNZ reduced rates to their current level of 4.75% with a 25-basis point (bp) cut on 14 August 2024 and a 50-bp reduction two months later on 9 October. Since then, some commentators have been calling for a 75-bp cut when the RBNZ releases its next Monetary Policy Statement on 27 November. At the same time, the minutes of the RBNZ's 9 October meeting showed that the central bank debated whether it should reduce rates by 25 bps or 50 bps. Although the RBNZ settled on the larger reduction in the end, we feel the minutes show that it was not a clear-cut decision. Furthermore, recent precedent shows that OCR reductions of 75 bps or more only occurred at the time of the global financial crisis in 2008 and around the start of the COVID-19 pandemic lockdown in 2020.

Need for balance seen influencing future trajectory of interest rates

In terms of the future trajectory of interest rates, there seems to be a near-consensus that the RBNZ will eventually lower the OCR to around 3%. In general, 3% is thought to be New Zealand's neutral rate of interest (the theoretical point at which interest rates neither stimulate nor slow down the economy). One side of the current argument on interest rates is that the RBNZ will need to cut past 3% to revive the economy, whereas others are concerned that excessive cuts could push inflation higher again. One question we see further complicating the picture is whether monetary policy will need to work harder to stimulate the economy given that the government's current efforts to reduce its spending. During the post-pandemic rebound, the combined effects of monetary and fiscal policy resulted in a strong recovery and high levels of inflation. Under the current circumstances, however, we expect the monetary and fiscal aspects to partially work against each other. The need to strike a balance between these factors is likely to be part of the RBNZ's calculations as the cutting cycle progresses.

Monetary policy seen as on track to revive economy but likely to take time

Our view is that New Zealand's monetary policy is on track to revive the economy, although the recovery will take some time. We expect a lag before the full effects of interest rate cuts are seen, and some areas of the economy are likely to deteriorate further from here before the upturn occurs. We believe that the obvious candidate for further deterioration is the labour market given that it often lags other sectors of the economy. In terms of the overall picture, we think that New Zealand's economic recovery will occur towards the mid part of 2025 and into 2026.