The OCR is down, so when will the market pick up?

At a time when our economy is still struggling, another cut to the Official Cash Rate has come as welcome news to mortgage holders. The Reserve Bank made the call to slash the all-important number by 25 basis points to 3%, and after pushing pause at its last meeting, the RBNZ’s Monetary Policy Committee (MPC) indicated a much more dovish view with two of its six members even voting for a 50 basis point cut.

Kiwibank Senior Economist Mary Jo Vergara says the cut was entirely expected, and the more important details centred around what the Reserve Bank would do to their two-year forecast.

“They've gone from signalling a 60% chance of going to 2.75%, to signalling an 80% chance of going to 2.5%. This is actually something we have been calling for since the end of 2023 as we knew the economy needed that stimulus.”

There are now two more OCR announcements before the end of the year, and it’s expected that each will deliver a 25 basis point cut to reach 2.5% by the end of the year.

Vergara says what wasn’t expected was a voting split between the MPC members.

“Not only did we see a four to two split, which was the first time two members had dissented, but also those two were favouring a 50 basis point cut which wasn’t really priced in by markets.”

Why are cuts taking so long to filter through?

It typically takes 12-18 months for the full effect of interest rate cuts to be felt. It's only been just over a year since the OCR started to drop in the latest string of cuts, which could explain the ongoing pinch, but Vergara says there are other factors at play too.

“There's just a lot of uncertainty, especially with what's going on overseas. We saw the economy kind of strengthen during summer, but that seems to have faded away with things like Trump's trade tariffs being introduced and that’s made businesses and households act more cautiously.”

“We haven't seen business investment as you'd expect, and we haven't seen housing consumption as you’d expect. This really isn’t the economy we were expecting a year after interest rate cuts, which is why we believe the RBNZ needs to deliver more relief.”

Vergara says the economic green shoots many have spoken about are only being seen within externally facing sectors, while domestically businesses are still waiting for the sugar hit.

“The saying was survive to 25, and now we are going with fixed in 26, and with further cuts coming we should hopefully see retail interest rates fall even more to help fix things.”

What's going to happen to house prices?

Just like the economy, house prices too have been sluggish. Vergara says pricing has tracked mostly sideways for the past two years.

“We know that demand is a big issue because investors have been sidelined for a really long time with policy changes and interest rates. At the current levels they're at, it’s just not attractive enough and not exciting enough for them.”

Having more investors will help to clear the backlog of listings, but Vergara doesn’t expect things to pique their interest until interest rates land at around 4.5%.

“Rental yields are a lot more attractive now because we’ve seen deposit rates fall so that yield differential is a lot better, but lower interest rates will also help things go a long way.”

“To make it worth your while the ideal is not having to top up your investment yourself.”

With less supply and more demand that’s when prices will start to climb.

How low will the rates go?

Vergara says there’s definitely room to go lower.

“On the day of the latest OCR announcement we saw wholesale rates price in two more rate cuts from the Reserve Bank, and we saw wholesale rates shoot lower. I think there’s a little bit lower to go and that will obviously flow through to retail rates.”

“We should get those retail rates closer to 4.5%. Most of the moves have already been made since the Reserve Bank started cutting, but I still think there is room for those retail rates to fall a bit more.”

But Vergara says there’s no chance of getting covid level interest rates again.

What if inflation keeps rising?

The OCR is the Reserve Bank’s most important lever for keeping inflation in its box and within the 1-3% target band. But it’s currently teetering right on the edge at 2.7% and is expected to climb. So, if it hits the boundaries and beyond, will the RBNZ hit the brakes on further cuts?

Vergara expects inflation to hit 3%, maybe even slightly higher, but says it shouldn’t be a cause for major concern.

“If you look at the drivers of that, it's largely coming from offshore, which the Reserve Bank has no control over.”

“Domestic inflation continues to ease because of how weak our economy is. So, for the Reserve Bank and for us, we're pretty comfortable with this near-term spike.”

Vergara says long term; she’s picking inflation to return to around 2%.

“You might see that headline inflation level creep a little bit higher, but as long as inflation expectations are well contained, which they are, the Reserve Bank should be able to continue cutting rates.”

So, while it's been a slow burn, it’s hoped the market will start to turn a corner both in activity and pricing.