Why central banks cut rates quickly

Published Nov 24, 2024, 8:27 PM

[VIDEO EPISODE ON YOUTUBE & SPOTIFY] Interest rates are continuing to be cut, with another Reserve Bank move expected this week. How soon will it result in economic relief?

The information provided in this program is of a general nature and is not intended to be personalized financial advice. We encourage you to seek appropriate advice from a qualified professional to suit your individual circumstances. Interest rates are continuing to be cut. How quickly could it provide economic release?

What's clear to me though, is that the New Zealand economy needs lower interest rates. GDP is reasonable and not good on a capital basis. It's terrible, but it's a soft ish landing, so usually they go down very fast. I mean, it's interesting. Of all the meetings that the Arbanza's had since nineteen ninety nine, about two thirds of them they do nothing, so.

The rates unchanged.

Of the third where they move rates, about sixty percent of the time they hike, and about forty percent of the time they cut, but they hike by smaller amounts. They hike in twenty fives because they're cautious, and when they cut they cut a lot because they're worried.

No.

Good to see you as always, Thank you medicine. It's nice to be back.

Thank you so much for doing this. Rates they're obviously going to continue to be cut. The question is to what degree I guess the answer, if you can explain this part to us, is how weak the economy really is.

Yeah.

Well, the ibn Z will meet next week and the consensus is that they'll cut again by fifty basis point. They've already cut by seventy five points this year, so that will give us one hundred and twenty five points of easy So that's meaningful. That will put New Zealand's cash road below Australia's for the first time in about three or four years, where it was very briefly below, but actually it's more like an eleven year low, so this is an unusual part of the cycle. The consensus for next week is fifty, but the market thinks as a chance of seventy five, just a small amount of pricing for that, and I think there's a reasonable case for seventy five, which we can talk about if you're interested.

Well, we heard from the Treasury Chief Economic Advisor that the recession we're in now is actually worse per capita than the GFC, So the economy's looking pretty terrible. What do you think the reserve band will be weighing up in terms of stats and activity at the moment.

Yeah, I mean that's yesterday's speech by Dominic was interesting and that it was considerably more downbeat than the fortnightly Treasury updates that we've been getting, which have actually been talking about a bottom being put in place and signs of a pickup.

So that was a little bit of a surprise.

But what Dominic is correctly identified is that the tax take is lightly down, particularly the GST number, the psize, the performance of service indexes and the pmis and manufacturing they're really weak. I mean, the PMI I think has been negative for twenty months and the PSI for something like eight months back to back, so we're clearly weak. The rbn said, know this, and that's why they're cutting interest rates. Now how far they go with this is the question. The market is toying with the idea of a seventy five basis point cut. There are good reasons that the RBNZ could consider that, but I think what the RBNZ will do is fifty because they're very keen to portray an image of a central bank that is slowly, carefully, very very pointedly adjusting a cash rate in response to the economic signals that they're getting, and so the picture they're Painting is one of the central bank that's gone inflation under control without wrecking the economy. Unemployment is still below five percent, the exchange rate is calm. GDP is reasonable but not good on a capital basis. It's terrible, but it's a soft ish landing, so they'll continue with that. The idea of a seventy five a thing is harder because it suggests perhaps that there's a little bit of panic, and I think they're very keen to avoid that.

If they're being timid, then what does that suggest to you about where this ends, about where the cycle finds a floor. What is that rate to look like? I mean, I've heard from Christian Hawksby that it's around three percent. Would you say the stats kind of sueduesce that that's about right.

Yeah.

It's the RBNS that has talked about the long term neutral and the short term neutral interest rates, So I think Christian was talking about short term neutral there. The long term neutral is around two point seventy five, so somewhere between two point seventy five and three and a half is kind of neutral in the short term. Now, whether we need to be below neutral at the moment or act neutral is the discussion, you'll see some economic competators suggesting already that the pickup is starting to come through for next year. We've got a great dairy price, We've got really good kiwi fruit earnings.

The meat industry is doing very well.

At the same time, the property sector is really soft and business is soft because government is contracting. So you've got some divergent forces. And this again is what will be feeding into the RBNS. It's thinking. So when they look at this, they won't be looking at one side or the other. They've got to take the ad and the aggregate says interest rates lower, probably towards three and a half.

On the point of producers, though, if you ask them, if you ask farmers and anyone in that secret they would say, yeah, but ten bucks isn't the old ten bucks.

Their costs are still enormal. Absolutely, So it's even though.

Those figures look like that, it's not exactly the same as previous cycles, is it.

I think that's exactly right, Madison. It's not the same.

So whatever ten bucks today is, it's probably more like six bucks, you know, ten years ago because of cost adjustment. But the reality is it's not seven bucks, which is where we were worried it would be because of the slowdown in the Chinese economy, and there's optimism that we could hang around these levels. If China continues to stimulate, that will be helpful, because it's unlikely China will stimulate the way they've stimulated in the past. They're not going to be building more airports, more bridges, more roads that consume iron ore film or coal cocon coal. They'll be putting stimulus, we hope, into the services side of the economy, and that will mean consumption and that's good for New Zealand well.

On stimulus here domestically, if we continue to get cuts, whether it's fifty seventy five anywhere around that, when does that actually flow through to the economy. When does that actually transmit and provide economic relief.

I think it's already coming into the economy, but it's hitting different parts of the economy at different at different pace. So in one of the rbnsa's most recent releases, they talked about the mortgage rate. The average mortgage rate, so this is the rate that the average mortgageholder in New Zealand feels is at four point six percent. It's just peaking now, even though they've been cutting for some months, and they've cut by seventy five points. The actual rate that the housing sector is feeling has been going up, and that's because of mortgage rollovers, so it takes time for this to come through. Now, the rbn's EDS assessment is at about I think half of all mortgages will refix in the next six months and about seventy five percent in the next nine months. So as they refix, they should refix at lower rates, so that will start over some of that stimulus.

But the lower rates they'll fix out won't be as low as.

The official cash brod may go and aggregate because the pool of mortgages will still grow and we've still got new people buying houses. The numbers should come down, so you will get some stimulus through that. But of course, if the rbns that are aggressive, which I think is a case from them being, they'll bring that number down much more quickly.

If we sum that up, then that's just that whatever a cut we get pre Christmas won't be felt and full until what next Christmas.

Shot for the housing sector, it'll take a while.

What about other sectors, what about consumption and that sort of thing. Is that more immediate.

Yeah, I think there are.

I mean, certainly for the currency, you would expect there'd be some adjustment. I mean I mentioned that if we do cut interest rates by fifty points, next week will be below Australia. That's the first time in a long while that's happened. You would expect us to weaken against the US dollar as well, and especially if the Fed start to slow their easings and perhaps hold under Donald Trump. In that environment, our export earning should increase. You know, we obviously don't know what's going to happen with the tariffs, but there is some hope that we get some more currency advantage, so different parts of the economy will will react in a different way.

I wanted to talk to you about what Donald trump result means for the US economy because this is the first time I've seen you since since that happened. What does it mean specifically for our economy if there are tariffs, and what does it just mean for trade because we play in that space. We're so reliant on exports and imports in this country. Is the concern that this could result in more fragmentation or is it ultimately positive to have a strong US economy for the world.

I think there's no doubt that a strong US economy is a positive. It's absolutely a positive because of the level of consumption. But the reality is the US economy is actually quite a closed economy. You know, it buys themselves from itself. It's not as open as we are Australia, or even as China in many ways because of China's a large external trade balance. But it is a positive for US. I mean, the challenge are all the same. So I talk to a number of different central banks and the challenge they all have is that they just don't know. So trying to forecast anything beyond January twentieth, next year, when Trump is inaugurated is really difficult because you know, I think the issue with Trump is trying to decipher what he's going to do versus what he says. And one of the wisest things I think I've read about Trump is to take him seriously, but don't take him literally. And what he's serious about is tariff's. You know, whether he's serious about sixty percent tariffs on China and ten to twenty on the rest of the world, well, we're not sure. Pretty serious about tariff so there's an assumption that there will be tariffs imposed on China. Now how that plays out depends on what China does. If China responds in a way that allows the tariffs to be relatively low, they agree to buy more US goods, they import more things from the United States, and they take more goods and the trade surplus diminishes. That's okay, everything will go very calm. If the Chinese respond with their own tariffs on the United States and there's a standard off, then we've got an issue because both sides have then got to replace that market. So what do the Chinese do with all the surplus goods that they've been selling to the US. If they start to dump those everywhere else in the world, that will be deflationary. And then you're going to get countries outside of the US who will complain because it's hurting their domestic industries, and then they will put in tariffs. So you could see that spiraling quite quickly. So that's one risk that they've got. So that's deflationary risk.

On the upside.

The inflationary risk is tariffs cost more, and if you close economies, you remove comparative advantage, you remove competition, you drive up prices, which is effectively what we saw during COVID. The economy became closed and so the cost of everything went up, especially labor.

What did Ray Dalio call them a corporate rid entering into a hostile takeo it?

So I take him seriously? Bottom line?

Yeah, I think we should take him seriously. And I don't think everything I've read says that he didn't expect to win last time, or he expects and what he expect deed to win this time.

So he's going to be much better prepared.

You mentioned that central banks have no idea what to make of all of this, because either way inflation, real, deflationary the very very different impacts on the economy. How do you think that that could impact their short term decisions like the one from the Reserve Bank we're about to get perhaps also with the RBA, you mentioned that you think that the Reserve Bank of New Zealand is going to be more cautious. Is that also playing on their mind? Is that a reason why they're going to be slower in their.

Approach to cut? No?

I think I mean the decision next week and the immediate decisions for all central banks will not include anything to do with the potential Trump tarriffs or Trump two point zero or Trump forty seven, whatever you want to call him, because they just don't know. The Central Bank always will say when we see the policy and we can analyze the policy, we can model the policy, then we will incorporate it.

Right now, it's not something they can model, so they'll simply ignore it. Now.

That doesn't mean they won't be talking about it around the table. I'm sure Donald Trump's name is one of the most frequently used in the discussion that they're having, but it's not something they can put into the forecast yet.

So if you could forecast twenty twenty five at all for US sean, obviously a lot of unknowns, but what a rate's going to look like? What are the sort of biggest watch outs for our economy and also for the world right now?

Yeah, I mean, I don't know that I can forecast much past about the middle of the year because we just don't know what the United States is going to do with tariff and how China is going to respond. So, you know, I read lots of forecasts where people have this dominant view about interest rates are going up, are going down, and I say, what, maybe I'm just not sure.

You know.

What's clear to me though, is that the New Zealand economy needs lower interest rates. So we're definitely going to have a lower cash rate going forward. The question is how quickly we get there. Now, for us next week, it's probably fifty, it's probably a fifty point cut, but there's real merit in my viewing going seventy five to get ahead of this. You know, you mentioned Dominic stephens speech yesterday. Dominic outline what we all know, which is at the economy is very very weak.

That's the first thing.

The second thing is that this is and this is perhaps the most important factor, is the calendar.

This is the last meeting of the year. There's eighty four.

Days until the next meeting in February. Now, any other time of the year we'd have a meeting every six weeks, so this is effectively two meetings. And if it was any other time of the year, what we'd expect from the Central Bank is that they would cut fifty at one meeting and then probably fifty at the next one. Well, they've got a two fo here, so expecting seventy five is not unreasonable. In my view, But they have to explain that, I think pretty clearly to people now. They don't normally go seventy five. They've done it twice, so you get that story in history. So since nineteen ninety nine, when the OCI was first introduced, they've only ever moved the cash rat by seventy five basis points twice was that up or down bone moved it now and once going into COVID, and then they moved it up once by seventy five coming out of COVID as infleation started to rise quite quickly. They've moved three times by more than seventy five during the GFC when they cut aggressively, once by one hundred and twice by one hundred and fifty. So usually they go down very fast. I mean, it's interesting. Of all the meetings that the ibnz it's had since nineteen ninety nine, about two thirds of them they do nothing, so the rate's unchanged. Of the third where they move raids, about sixty percent of the time they hike, and about forty percent of the time they cut, but they hike by smaller amounts. They hike in twenty fives because they're cautious and when they cut, they cut a lot because they're worried. So it's always on the downside where you get the bigger moves. And also, interestingly, if you take the whole history of the ocr we started off at four and a half percent, We're at four seventy five today. We'll probably be at four and a quarter next week. The long term average is four percent. They've hiked thirteen percent cumulatively, and they've cut twelve point.

Seventy five percent. We're back when we started about where we started.

None of us really matters, just back at the starting point.

If you left New Zealand's twenty five years ago and came back today, you go, oh, this looks pretty familiar.

And we know that Adrian or is an opposed to a shock factor pre Christmas.

I remember he did a.

Fifty hike a couple of years ago. Because there is that wait to come, We'll stay tuned absolutely.

I mean it's always interesting.

Well, thank you so much for explaining it incredibly well to us, not only this year, but in previous years as well. You're actually the most frequent contributor to the show.

You've been on three.

Times this year, and you are always giving me ideas behind the scenes as well, and I appreciate your knowledge always.

Thank you so much, thank you

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