The Reserve Bank (RB) predicts modest economic growth over the rest of this year.
By contrast, there are good reasons to believe economic activity or Gross Domestic Product (GDP) is falling again. This should mean mortgage interest rates that are already nudging lower will fall more this year and drive some recovery in residential building next year.
Contrary to what the RB predicts, the most useful indicator points to GDP falling (first chart). The BNZ-Business NZ survey has accurately predicted past falls in GDP. Supporting the case for falling GDP is falling monthly online card spending (second chart) and a halving of online job ads since January 2022 that implies firms will be in the process of cutting capital spending.
With economic growth looking to be significantly worse than the RB predicts, enough progress should be made in cooling wage and price inflation to justify lower interest rates. A fall has already started. Following modest falls in wholesale interest rates, the average mortgage rate offered by the major banks has fallen from a recent peak of 7.29% in December to 7.09% in early-July.
It is nothing new for the RB to be well off the mark with its forecasts because it is often out of touch with what is happening at the coalface of the economy. For example, over the last 18 months GDP has fallen in consecutive quarters twice – what economists call recessions - and the Reserve Bank did not predict either.
When the RB gets it wrong the market can lead the way with interest rates as has started to happen. For example, the 2-year wholesale interest rate has fallen from a peak of 5.79% in October 2023 to 4.96% at the time of writing, while the average two-year fixed mortgage rate offered by the major banks has fallen from 7.06% to 6.77%.
The two-year wholesale interest rate is based on what the market expects the Official Cash Rate (OCR) the RB controls to be over the next two years. If the market starts to expect OCR cuts over the next two years, the two-year wholesale rate will fall ahead of the OCR.
The market is yet to fully appreciate how much worse economic growth will be relative to the RB’s predictions. If falling GDP is confirmed over the next couple of quarters the market should expect more OCR cuts and push wholesale rates lower.
