After another Official Cash Rate hike, Kiwi Economist Rodney Dickens shares his thoughts.
The Reserve Bank hiked the Official Cash Rate 0.25% to 2.75% in September and predicts it will increase it 3.3% by 2029, implying around two more 0.25% hikes (see the first chart). How many more hikes there are will depend on future developments that are harder to forecast in a world that seems to go from one crisis to the next. But a few early hikes should be viewed as good because they will hopefully eliminate the need for more painful ones later.
The first chart shows some wild swings in the OCR. These have caused major cycles in mortgage interest rates, which are the most powerful driver of upturns and downturns in residential building.
A consequence of the wild cycles in interest rates is shown in the second chart. It shows major cycles in the unemployment rate, flowing through to major cycles in base labour cost inflation. The red unemployment rate line has been advanced or shifted to the right by four quarters to reflect how long it takes changes in this indicator of bargaining power between employers and employees to flow through to labour cost or wage inflation.
By keeping the OCR too low, at times, the Reserve Bank has overheated the economy. This is reflected in the unemployment rate falling below my 4.5% estimate of the rate consistent with the Reserve Bank’s CPI inflation target. With this followed much higher labour costs and price inflation. The Reserve Bank has then responded to the higher inflation with aggressive OCR hikes that drove major falls in residential building activity.
With the unemployment rate at 5.6% in the June quarter, there is spare capacity in the economy that will help dampen inflation. However, changes in interest rates take around 2.5 years to flow through to inflation.
Much of the boost to inflation from the large fall in interest rates from late-2024 to early-2026 still lies ahead. If the Reserve Bank left the OCR below average for much longer, economic growth and inflation would end up too high. This is especially the case now, when below average population growth is limiting growth in the workforce. This means it will not take particularly strong economic growth to drive the unemployment rate back down to the rate consistent with the Reserve Bank’s CPI inflation target.
The OCR hikes the Reserve Bank is delivering may seem premature to many. They are not, once allowance is made for how long it takes for interest rates to impact on inflation and the low population growth. A few timely hikes will hopefully avoid the need for much more painful hikes in the future.
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