Inside Economics: The RBNZ's dilemma – a two-speed economy and a one-speed OCR

NZ Herald

2 days ago

That's the bit that's going to generate all the reaction.
Everyone will have an opinion on how it has assessed the outlook.
A 25-basis-point (bps) rate cut is considered a certainty by both markets and a consensus of economists.
That will take the Official Cash Rate (OCR) to 3% from 3.25%.
It follows a pause in May but a sharp easing of interest rates in the past couple of years, with the rate having come down from a peak of 5.5% since last June.
The big question is: how much more easing is needed to ensure a solid economic recovery?
There is no easy answer, and economists are divided.
On one hand, after a solid first quarter, the recovery seemed to stall in the second quarter as the threat of tariffs and international trade wars rocked confidence.
We won't see the Gross Domestic Product (GDP) figures for the second quarter until mid-September.
At Westpac, the economics team are relatively confident that a rate cut today will be enough to do the job and are forecasting a long pause from the Reserve Bank (RBNZ) from here.
Westpac chief economist Kelly Eckhold expects the RBNZ to leave its forecast rate track largely unchanged (which would still leave some chance of another rate cut by November).
But he doesn't think we need it.
'A large part of the case for easier conditions in April and May was predicated on the global situation seriously spilling over to New Zealand,' Eckhold says.
'There might have been some of that in business and consumer sentiment in recent months. But mostly this hasn't happened.'
But at Kiwibank and ANZ, the view is a little more pessimistic on the recovery, with both arguing that two more cuts (after today) may be needed, taking the rate to 2.5%.
'The weakness in the economy demands stimulus,' Kiwibank chief economist Jarrod Kerr writes.
'With all the risks offshore, and the pain still felt onshore, there's a good argument to be made for taking policy into stimulatory territory ASAP. An argument that is growing in support.'
ANZ chief economist Sharon Zollner agrees but doesn't think the RBNZ will give much away today.
'We expect the RBNZ to pivot more dovish and ultimately cut the OCR to 2.5% as the soft high-frequency data increasingly shows up in the hard data,' Zollner says.
'But next week is likely too soon for a lurch in that direction.'
Two-speed economy, one-speed cash rate
So why not just cut the rate lower? Well, as always, the issue is the risk of inflation.
We know food prices have been elevated. According to last week's Selected Price Index, the annual rate of inflation for food is a worrying 5%.
Whether that worry is primarily one for grocery shoppers or whether it should worry the RBNZ depends on how low levels of demand in the economy have really fallen.
One of the problems that the RBNZ faces in assessing this is that we increasingly have an economy that is running at two speeds.
But it only gets to set one OCR.
There has been plenty of commentary about New Zealand's two-speed economy in the past few weeks.
A gap is opening between the pace of recovery in provincial regions, which are feeling the direct flow from high export commodity prices, and the urban areas, which are suffering from low confidence and extended property market contraction.
As I pointed out in my column on Sunday, house prices are down from their 2022 peak in Wellington and Auckland by almost 30% and 20% respectively.
In Auckland, the official unemployment rate is 6.1% – compared to 5.2% nationally and just 2.9% in Otago.
If the RBNZ were just setting borrowing costs for Auckland and Wellington then the need for further cuts would be a no-brainer.
It might well slash the OCR down to a stimulatory level – like 2.5% (ie three more cuts) very quickly.
But it is hard to ignore an export commodity boom in New Zealand. It is bringing billions of extra dollars of foreign currency into the country, which must eventually spark some economic growth.
That's probably already happening in the south of the country.
The trouble is that measuring how long it will take to flow to the cities is not an exact science.
Lending data collected by the RBNZ show that the level of borrowing in the agricultural sector is falling.
It looks like many farmers are using strong returns to pay down debt.
That's good for the country in the long run, but may slow the economic sugar hit that increased regional spending will bring.
Monetary policy, as is often said, is a blunt instrument.
The RBNZ knows this and will no doubt be feeling the pressure mounting as it is forced to choose how heavily to wield it.
On that basis, I expect it won't give too much away today.
Another cut and a 'wait-and-see' outlook will buy it some time to see if the recovery can take hold in the cities, and which way inflation breaks.
Mixed messages from manufacturing, service sectors
Two of the more useful monthly indicators of economic performance – the Performance of Manufacturing Index (PMI) and the Performance of Services Index (PSI), produced by BNZ for BusinessNZ, were released late last week.
The messages were mixed.
The good news was that the manufacturing index returned to positive territory.
The seasonally adjusted PMI for July was 52.8 (a PMI reading above 50.0 indicates that manufacturing is generally expanding; below 50.0 that it is declining).
This was up from 49.2 in June and above the average of 52.5 since the survey began.
'After a couple of challenging months for the sector, the upswing in activity for July saw a return to levels of expansion seen during the start of 2025,' BusinessNZ director, advocacy Catherine Beard said.
But the services index remained in negative territory for the sixth month in a row.
The PSI for July was a contractionary 48.9.
Although the PSI improved from its previous month's value, it was still well below the average of 52.9 over the history of the survey.
'While the July result was a continued improvement from 44.3 posted in May, the sector has not experienced expansion for 17 consecutive months,' BusinessNZ chief executive Katherine Rich said.
On a slightly more upbeat note, BNZ's senior economist Doug Steel said that 'combined with recent improvement in the Performance of Manufacturing Index, electronic card transactions and ANZ's Truckometer, there are accumulating early signs of life in the economy'.
Aussie productivity woes
The Reserve Bank of Australia (RBA) has downgraded the long-term outlook for productivity growth and warned the economy is incapable of sustainably growing faster than 2% per year, the Australian Financial Review reports.
Of course, this doesn't solve any of our economic problems, but sometimes it is nice to know we are not alone.
It means the Aussies are now facing (or at least facing up to) the same structural economic problem that we've been battling for a decade.
Falling rates of productivity mean an economy's capacity to grow (without hitting capacity limits and causing inflation) also falls.
The New Zealand Treasury has been warning us about this for some time. Last year, it delivered a stark warning in a paper titled: The productivity slowdown: implications for the Treasury's forecasts and projections.
'While New Zealand saw a significant improvement in its productivity growth following economic reforms in the late 1980s, labour productivity growth has been slowing since before the Global Financial Crisis,' the paper said.
'It has fallen even further over the last decade. Productivity for the whole economy averaged 1.4% p.a. [per annum] between 1993 and 2013 but averaged only 0.2% p.a. over the last 10 years.'
What wasn't clear was whether the lower productivity of the past 10 years represented a new trend or a temporary phenomenon, the paper concluded.
The fact that the Aussies are now noticing the same trend is probably a bad sign.
Perhaps this is a chronic modern issue underpinned by big structural forces like the ageing population.
I've seen estimates that New Zealand's economy doesn't have the structural capacity to grow faster than 2.5% a year without generating inflation.
Maybe that's optimistic, and we're more likely tethered to the 2% rate of growth that the RBA is warning about.
Either way, it's a bigger problem for New Zealand than it is for Australia. That's because Australia has a lot more stored wealth. Its compulsory superannuation scheme has set it up well for the big retirement wave coming in the next decade.
While it's not ideal, Australia is better placed for an extended period of low and slow growth.
In New Zealand, we have higher levels of debt, lower levels of savings and a Government that needs to claw its way out of deficit.
In short, we need to generate higher rates of growth just to maintain the level of public expenditure we're used to.
So the pressure falls more heavily on this side of the Tasman to crack the modern productivity dilemma.
Although, having said that, we should keep an eye on Australia's progress, as any potential solutions would be gratefully received.
Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003. To sign up to his weekly newsletter, click on your user profile at nzherald.co.nz and select 'My newsletters'. For a step-by-step guide, click here. If you have a burning question about the quirks or intricacies of economics send it to [e-mail] or leave a message in the comments section.