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Monetary policy easing still somewhere down the track - Tony Alexander

It would be wonderful to write here that over the past month we have received sufficient new information on the state of our economy and the outlook for inflation to have increased confidence that monetary policy will be eased before the end of the year. Unfortunately that is not the case – though I do expect that time to come in the next few months.

Consider for instance the recent news that our economy is back in recession. This sounds bad, but the decline in output was only 0.1% in the December quarter which followed a 0.3% decline in the September quarter. That is certainly not a set of numbers which would leave one worried about inflation. But it is not extra deep weakness of the sort which would make our central bank immediately contemplate cutting the cash rate from the 5.5% they took it to in May last year.

That is especially the case if we note that one monthly measure of household inflation expectations has just climbed from 3.9% to 4.5%. Also, we still have almost a net 50% of businesses saying they plan raising their selling prices in the coming year whereas the long-term average consistent with inflation just over 2% is 25%.

Also, inflation is still 4.7% and it won’t be until we start seeing numbers with a three in front that the Reserve Bank will give benefit of the doubt to people and business price setters in particular believing that high inflation is solidly a thing of the past.

But there is a caveat to this discussion dismissing the case for an easing of the official cash rate anytime soon. The economy may only have shrunk 0.4% over six months, but this has happened during a year when the population has grown by almost 3% courtesy of a net migration boom.

There are a lot more people in our country now and one would have thought that their presence would give an upward boost to household spending. Maybe it has, but this boost has been offset by a crunch on spending by the one-third of the population directly affected by the strong tightening of monetary policy.

Just as the Reserve Bank over-stimulated the economy during the pandemic they are now almost certainly over-restricting it. At some stage there is likely to be a period of relatively quick easing of monetary policy with the cash rate falling by 1% in less than a six month period. My current best pick for when this might happen is the first half of next year but with one or two cuts before then.

What about the stimulus to household spending likely to come from tax cuts in the middle of this year? I expect them to be more than offset by spending cuts elsewhere, such as those currently going through a public sector which became bloated over six years with no clear improvement in output.

In fact, after six years of the previous government the ratio of government net debt to GDP has gone from under 6% to near 20% with higher child poverty, longer state house waiting lists, worsened productivity growth, new migration exploitation, and the highest net loss of Kiwi citizens on record.

As the new government initiates policies which have capacity (but not certainty) to reverse these things, we know from the hard years of the 1980s that such reforms can initially cause worsened economic conditions unless accompanied by an aggressive loosening of credit conditions as happened from 1984-87.

There is no chance of that happening this time around. For businesses the outlook for 2024 is not so good, especially those in retailing, townhouse construction, and some parts of hospitality not commonly frequented by the older generation (no mortgages).

For borrowers the incentive for the moment remains to fix short but with the high probability of fixing for the same term when the current one ends. At some point we will again be in an environment where fixing three years or longer will be optimal. But we seem 2-3 years away from that as yet.

Written for NZ Mortgages clients on 23/02/24.