Reserve Bank Governor Adrian Orr

Yesterday, the Reserve Bank confirmed there will be no free card for the economy to get out of jail during the current term of the Government.

Regardless of what the Budget next week says, we are in for two more years of austerity.

Over those two years, we will have to watch the Australian economy recover to normal.

Probably not since the Bolger Government of 1990 – 93 has any Government faced such a grim forecast for its entire term.

The Luxon Government must now persuade the country that we have no alternative but to pay the bill for the previous Government’s Covid profligacy.

The Bank issued its quarterly Monetary Policy Statement yesterday and reported that its Monetary Policy Committee had agreed to keep the Official Cash Rate (OCR) at 5.5 per cent.

But what has surprised the trading banks and financial markets is the Committee’s more negative outlook on inflation which means the OCR will have to stay higher right up to the 2026 election.

That will slow the rate of mortgage reductions between now and then.

The Committee has warned that if inflation is to be brought under control and remain inside the Bank’s 0 -3 per cent target zone, wage growth will have to be restrained.

So, though the “squeezed middle” may get some cost-of-living relief from next week’s Budget tax cuts, whether they get any substantial mortgage rate relief remains questionable.


The villain in the piece is so-called “non-tradable inflation”, which means locally produced goods and services, which rose 5.8 per cent in the year ended March 31.

Key ingredients included house construction costs, local body rates, local tourism accommodation rates and recreation services like subscription TV and cinema tickets.

Imported inflation was below two per cent for the 12 months ending March 31, according to StatsNZ.

The Committee agreed that interest rates needed to remain at a restrictive level for a sustained period to ensure that annual headline inflation returned to the one to three percent target range.

They are now forecasting that by September 2026 (just before the next election), the OCR will be at 5.2 per cent, above the 5.0 per cent they were forecasting as recently as February.

But it could have been worse.

“In the context of persistent domestic inflation, weaker productivity growth, and uncertainty regarding the pace of normalisation in wage and price-setting behaviour, the Committee discussed the possibility of increasing the OCR at this meeting,” their report said.

However, the Committee agreed that interest rates might have to remain at a restrictive level for longer than anticipated in the February Monetary Policy Statement to ensure the inflation target was met.

The so-called “hawkish” nature of this statement caught the financial markets by surprise.

Kiwibank’s economics team reported that the financial market reaction was swift.

“We saw the wholesale interest rates gap higher, with the 1-year swap rate up eight basis points (bps)  and the 2-year up 11bps, to break back above 5%,” they said.

“The moves fly in the face of recent bank retail rate cuts, especially on mortgages.

“Rate cut expectations for calendar 2024 are slowly evaporating.

“We believe the risk is tilted (heavily) towards an even higher move in wholesale rates in the coming hours and days.”

However, ANZ Bank Chief Economist Sharon Zollner was not convinced that the Bank would hold the OCR high for as long as it had forecast and that retail banks would still proceed with mortgage rate cuts sometime over the next year.

“Today’s Statement is not going to stop the market from making up its own mind,” she said.

“Offshore participants, in particular, are focused very much on the fact that headline inflation is forecast to be back in the band by the end of the year.

“However, the RBNZ doesn’t just want to see inflation back in the band –they want to be confident it’ll stay there, which requires a decent fall in non-tradable inflation.

“Our recently updated forecast for the big picture are similar to the RBNZ’s: the economy is slowing, the export outlook is challenged, and unemployment is set to rise.

“When that will provide the RBNZ sufficient confidence in the inflation outlook to ease the OCR will remain a point of vigorous contention.

“We’re optimistic that that will be earlier than the RBNZ currently expects.”

However, Reserve Bank Governor Adrian Orr does not share Zollner’s optimistic views.

Asked yesterday if the Bank’s projections theoretically implied that the OCR would have to rise to 5.6 by the end of the year, Orr said he didn’t buy into the “theoretically implies.”

“We’re saying the official cash rate peaks at around 5.6% there or thereabouts, and it’s likely to have to remain, in a restrictive level, for some time yet,” he said.

Orr was at pains to point out that the MPS had been produced without taking into account any possible fiscal moves, such as tax cuts in next week’s Budget.

But in a perhaps ominous warning, he pointed out that Government spending and investment as a proportion of total potential output were really important in determining the impact they had on inflation or disinflation.

Since the current GDP forecasts were published in the Half Yearly Economics and Fiscal Update last December, GDP growth has been lower than forecast.

“Due to weaker potential output growth, government expenditure is higher as a proportion of potential output than projected in the February (monetary Policy) Statement and hence less disinflationary,” the Committee said.

That might suggest there could be more pressure on Finance Minister Nicola Willis to minimise any inflationary impact from the tax cuts.

Orr suggested that the timing of any tax cuts in the Budget could be important.

“The timing between government savings and government spending; these things can also have, at the margin, different implications for inflation pressures and monetary policy,” he said.

What is clear is that regardless, the Government is going to have to keep up the pressure on spending.

There is unlikely to be any room for “nice to haves” over the next three years.

ANZ Bank senior economist Mikes Workman says the Government will not be able to end the cuts in this Budget; they will have to continue throughout its three-year term.

The big test for this relatively new Government won’t just be in signalling an overdue fiscal consolidation; it’ll also need to follow through over coming years,” he said earlier this week.

“While the cupboards may be bare from an additional spending perspective, we think there will still be scope for further reprioritisations from within existing baselines as new cost pressures arise.

“There’s also scope to consolidate faster via deeper spending cuts if desired.

“Indeed, even after proposed tax cuts are delivered, and after we strip out the impact of high inflation on delivering public services, we estimate the public sector will still be meaningfully larger than it was prior to the pandemic.

“That suggests the Government should be able to find further cost savings to replenish the cupboards over coming years if they so desire.”

 That will be the story of the next three years: austerity, and that will be a daunting political challenge for the National-led Government.