MNI: RBNZ Hike Likely Despite Weak Economy - Economists

The Reserve Bank of New Zealand is likely to hike the Official Cash Rate a further 25 basis points to 3% when it meets on Oct 28, but a persistently weak economy and higher diesel prices could limit further increases, external economists told MNI.

“The last thing you want to do is to let [inflation] run away or get ahead of you. That was the lesson of the last cost shocks,” Cameron Bagrie, managing director and chief economist at Bagrie Economics, told MNI. “If you think you need to go, then get the job done.”

Markets currently see an over 80% chance of an October hike, a view Bagrie shares. While Q3 inflation, due Oct 22, may come in below the RBNZ's forecasts, particularly given softer readings in some monthly price indices, core and services inflation are likely to remain above the 2% midpoint target, making the case for further tightening, Bagrie argued.

Most core inflation measures have been running between 2.5% and 3%, with some in the low 3% range, he said. "I don't trust any single economic piece of data, but I look at the broad trends across a whole lot of different measures to see what that core inflation pulse is. It's still going to be elevated, and the economy outside of housing is moving into a pretty good space. We've 2.6% annual growth in the last 12 months, well above the productive capacity or potential growth rate which is estimated to be around 1.5-2%. We're whipping away spare capacity."

A further 25bp hike would be unlikely to cause significant economic damage, he added, though higher capital costs could eventually put pressure on asset prices. Bagrie expects the OCR to peak at around 3.8%, broadly in line with market pricing. 

DIESEL COSTS

However, Michael Reddell, independent commentator and former RBNZ special adviser, believes market expectations for the OCR remain too high, warning elevated diesel prices could ultimately weigh on economic activity. Reddell was less convinced that the neutral OCR was materially higher than before the COVID-19 pandemic, arguing that weak productivity growth, subdued migration and modest nominal GDP growth pointed to a relatively low neutral rate closer to 3%.

Headline inflation is likely to rise again as petrol prices climb above their earlier-year peak, but business confidence could weaken, he said. "The Bank's nowcast was already revising down those growth estimates for later in the year," he added, noting that the monetary policy committee faces a difficult decision. "They bought themselves the opportunity to wait until December with that statement last month, but they will be uneasy about the fact that we've had another inflation shock, even though it's a supply shock, even though demand's weak." (See MNI RBNZ WATCH: Breman Takes Cautious Stance On Further Hikes)

The Oct 28 decision could be closer than markets anticipate if Q3 inflation comes in materially below the Bank's forecast, he argued. However, if policymakers believe another hike will be needed this year, October may be preferable to December, when the Bank would face additional uncertainty over fiscal policy following the Nov 7 election. An October move would also allow policymakers to act ahead of the full effect of higher petrol prices is reflected in Q4 inflation, he argued.

The outlook for petrol and diesel remains a major uncertainty. "Diesel demand is relatively price-inelastic, meaning global supply disruptions could force businesses and consumers to cut activity rather than simply reduce consumption costs," he added. Unless geopolitical tensions involving the U.S., Russia and Iran ease in the coming weeks, diesel supply risks could add to economic headwinds, he concluded, adding that policymakers should continue to account for this risk within the RBNZ's significant negative output gap estimates.

MNI: Meloni Tax Cuts Depend On EU Flexibility -Sources

Italian Prime Minister Giorgia Meloni’s flagship plans to lower income tax for middle-earners and extend the 15% flat tax for the self-employed to those making up to EUR100,000 a year will depend on the outcome of negotiations with Brussels over more flexibility for an exemption to Europe’s fiscal rules to cover expenditure related to higher energy costs, Italian government sources told MNI.

Italy’s Draft Budgetary Plan (DBP) submitted to the European Commission on Thursday does not provide enough resources to fund either the extension in the flat tax from the current EUR85,000 limit or an increase in the threshold for the 33% rate on income tax to EUR 60,000 a year, one source said, pointing to figures in the official document.

But Meloni and her allies need to deliver on their promises to reduce Italy’s tax burden in their last budget law before the 2027 general election, though without jeopardising the fiscal consolidation achieved in recent years, sources said.

“It would be like being almost at your house or car payment loan after many sacrifices and not to pay just because you can’t go out for dinner,” one source close to Finance Minister Giancarlo Giorgetti told MNI. (See MNI INTERVIEW: ECB Should Halt QT - Bini Smaghi)

FLEXIBILITY

Italy is negotiating three separate issues with the European Commission which could affect its fiscal room for manoeuvre.

The first is exiting the Excessive Deficit Procedure once it is confirmed that the country will close 2026 with a fiscal deficit below 3% of GDP. This is usually confirmed by March, but Italian officials believe the decision could come a few weeks earlier. Leaving the EDP would allow Italy to spend EUR29 billion on defence and energy investments in 2027-28, with around EUR14 billion allocated to each.

The second request, on which Italy is more optimistic, according to sources, is to use part of the additional spending allowed for funding long-term investment in energy infrastructure under the National Escape Clause to Europe’s fiscal rules for measures included in the draft budget.to lower energy prices for households and businesses.

This would allow Italy to use the additional fiscal room to spend more on tax cuts for the middle class, one source said. The DBP allocates EUR2.2 billion to “fiscal measures”, but this would not be enough to fund the nearly EUR3 billion cost of extending the income tax bracket, the source added.

MNI INTERVIEW: High Yields Mustn't Deter BOE-Ex MPC's Saunders

Rising bond yields should not deter the Bank of England from raising rates, and any dovish shift due to shifting yields might be perceived as akin to fiscal dominance, former Monetary Policy Committee member Michael Saunders told MNI.

In addition to an inflationary impulse from the Iran war, the economy's faster-than-expected growth may reflect early signs of a boost to output from AI, Saunders said, adding that market pricing for a widely-expected BOE hike in November followed by three further hikes is not necessarily exaggerated.

A dovish turn in response to a shift in gilt yields primarily driven by concerns over the UK’s fiscal position would be dangerous, he said.

"If yields go up because of lots of government debt issuance, and you, as the policy maker, respond to that rise in yields by being more dovish, then markets will say, ‘Oh, so you're ... giving governments a green light to be loose fiscally? In that case, all our worries about long-term unsustainable fiscal trends appear more valid,’" said Saunders, now at Oxford Economics.

As a result "inflation expectations will be higher, and the outcome is that life for the central bank will be worse, not better,” he said.

WHAT DRIVES YIELDS HIGHER MATTERS

Saunders pointed to a 2006 speech by Ben Bernanke in which the former Fed Chairman stressed that the monetary policy response to changes in yields should vary according to what drives them. Bernanke’s framework suggests that while a central bank could reasonably compensate for rising term premia with easier policy, a jump in yields driven by inflationary expectations should be met with tighter policy. Saunders, however, cautioned against looser policy to offset higher premia.

Monetary policy concessions to fiscal concerns could be viewed as adjacent to fiscal dominance "and that's just a bad position for a central bank to be in. So if you think risk premium is due to either unsustainable long-term fiscal trends ... or heavy public debt, issuance, I would say the response of the central bank to either of those can't be dovish," Saunders said.

However, he noted that the BOE's decision in September to slow the pace of its gilt sales and to retain a substantial portion of its holdings to back the currency was not, contrary to some speculation, a response to the rise in yields. (See MNI INTERVIEW: BOE Has Scope To Retain More Gilts- Fisher)

"They took the decision to do this several months ago, rather than just in response to rising yields in the last month or two," he said, noting that recently-published minutes of the Bank of England’s July Court meeting, showed the Court then being briefed on the changes. (See MNI INTERVIEW: BOE MPC Shouldn't Lead QT - ex-MPC's Saunders)

Current hawkish markets rate pricing is plausible, he noted.

If energy prices stay high in line with the adverse scenario from the August Monetary Policy Report, "then the market yield curve doesn't look excessive, because the risk of second-round effects would be greater due to a larger and more persistent energy price shock, and the central bank would have to lean against them," Saunders said.

BAILEY'S TIGHTENING CALCULATIONS

While BOE Governor Andrew Bailey has argued that leaving policy on hold in the wake of the outbreak of the Iran war has been roughly equivalent to 75 basis points of tightening, since 75bp of easing had previously been priced in before the conflict began at the end of February, Saunders said that more tightening is needed.

“If you think you need to do more than 75 basis points versus your pre-war expectation, then you need to hike the policy rate outright, and that's where we are now," he said, noting that Bailey’s reckoning did not account for the loss of “the signalling effect of announcing a higher policy rate, which is surely worth something.”

The BOE must also factor in unexpectedly strong recent UK growth data, which Saunders considers may be showing the first signs of a boost from AI. 

AI may be "adding materially to overall output growth in the last quarter or two ..It's the sectors which are involved in using AI very directly, as opposed to … [those] for which AI may be an input but isn't yet revolutionising productivity, " he said. (See MNI POLICY: BOE Explores Patchy UK Productivity Gains From AI)

MNI INTERVIEW: Fed Rate Must Near 5% To Tame Inflation-Lacker

The Federal Reserve will have to raise interest rates quite a bit further in order to make monetary policy restrictive enough to bring down a stubbornly high rate of inflation, former Richmond Fed President Jeffrey Lacker told MNI. 

“The indicators, based on historical relationships, suggest that the rate needs to be closer to 5% to get inflation down,” Lacker said in an interview. 

“If you look at Taylor rules of various sorts, I don’t hang my hat on any one particular rule but if you look at a broad range of them, four-and-a-half to five-and-a-half is where they say we ought to be.”

That’s partly because rapid economic growth is lifting the neutral rate of interest, he said. 

“The acceleration in current demand certainly suggests that you're going to need higher real interest rates in order to induce the balance for current resources that you need to keep inflation under control,” said the former FOMC member. 

URGENCY

Lacker said there is a disconnect between the Fed’s statement that September’s increase in the fed funds rate to 3.75-4% would support a “timelier” return to the 2% inflation target, and communications by top Fed officials signaling a lack of urgency in tightening policy.  

“I’m surprised at the lack of urgency they feel about getting inflation down,” he said. “It's been three or four years now where inflation has been predicted by them to return to 2% within a year, a year-and-a-half and it's remained at three or three-and-a-half,” he said. “The longer that happens, the story that we just had some bad luck and some adverse supply shocks each time, strains credulity.”

The September CPI report released this week showed a 3.7% rise in headline inflation and a 2.6% annual gain in core. A monthly rise of 0.3% in core reignited bets on an October hike after officials downplayed the need for such a move.  (See MNI POLICY: Fed In No Hurry But Committed To Taming Inflation) 

“Core inflation has been firming this year. And what’s more, you’ve got nominal GDP, nominal spending, that’s been accelerating this year.”

AI INFLATION

Strong demand for products and services linked to the AI boom have created a fresh inflationary risk, but one that is squarely within the Fed’s remit and control, said Lacker. 

“Uncounteracted, unmanaged, the AI boom is going to be an inflation problem. But it doesn’t have to be. The right response to a large increase in investment demand is for real interest rates to rise to get other sectors to restrain their spending to make room for it,” he said. (See MNI POLICY: AI Buildout Emerges As Top Inflation Risk For Fed) 

BALANCE SHEET

Asked about Fed Chairman Kevin Warsh’s five task forces, Lacker said he hopes the one looking at balance sheet policy counsels the central bank to be less interventionist in money markets, which might allow the Fed to shrink its asset base significantly. 

“I’m hoping that the balance sheet task force encourages the Fed, induces the Fed, to rethink its aversion to money market volatility and money market spreads,” said Lacker.

“The Fed’s skittishness about repo market volatility is a new thing and I think that’s what drove them to stop running off the balance sheet last year. It kind of has a look of paranoia at this point.”

MNI INTERVIEW: RBA Hike Risk Remains, Despite Jobs Data

Risks the Reserve Bank of Australia will hike the cash rate again this year from its current 4.6% remain skewed to the upside despite September’s weak labour market data, with a former RBA economist warning the figures may be distorted by the Australian Bureau of Statistics’ modernisation of its data collection methods.

“We always talk about looking through seasonality around the end of the calendar year, and I think this could be a case of looking at the trend numbers now, or even the [non-seasonally-adjusted] numbers,” said Blair Chapman, senior economist at SEEK and a former RBA research economist, pointing to the 10-basis-point rise in September's unemployment rate to 4.7%, above the 4.6% consensus forecast, and the 39,000 decline in employment versus expectations for a 20,000 increase. 

The sharp swings in employment over the past two months suggest the data may be volatile, he added. “When you take a step back and look at it, movements over the last couple of months, it's a bit softer, but it's not as obvious that there's a massive deterioration. It looks a lot more orderly when you do that,” he said.

The ABS has warned that its modernisation could affect the data, Chapman added, pointing to similar major changes made to the labour force survey in 2014 that altered seasonal patterns for several years. The RBA is likely communicating with the ABS to understand the effects of the changes better, giving policymakers more insight than the market, Chapman added. Unless inflation eases significantly, however, the weaker labour market data is likely to have only a marginal bearing on the Board’s November decision, he argued.

KNEE JERK REACTION

RBA-dated overnight index swaps fell 4-8bp across meetings following the labour force release, with markets now pricing in a 16% chance of a hike at the Nov 3 meeting. 

Chapman said the market reaction was overdone, adding that he would still put the probability of a November hike above 50%, and noting that trend unemployment remained steady at 4.6%. “I think it's definitely a bit of a knee-jerk,” he said, arguing that markets had focused on the results without fully accounting for the ABS’s warning.

The labour market may also be showing signs of stabilisation, with job advertisements turning higher over the past month or two. Stronger seasonal hiring for tourism and other industries ahead of Christmas could support employment in the coming months, Chapman noted.

A hike in November when the RBA, will release its Statement on Monetary Policy alongside the meeting, is more likely than a December move, he continued. 

The RBA has faced criticism for being behind the curve on inflation, Chapman noted, and delaying a hike until December could reinforce that perception. The Bank will also have opportunities to communicate its policy outlook before the November meeting, making its public messaging worth watching, he concluded.

MNI POLICY: Trump Officials See Firm Growth Mitigating Debt

Trump administration officials are counting on robust growth driven by AI productivity to boost the U.S. economy’s potential and its long-run capacity to service debt, downplaying fiscal sustainability concerns from the IMF this week and showing no sign of any course correction on debt policy, MNI understands.

The president has said oil prices will fall "precipitously" once the U.S. wins its war with Iran, and the administration is hopeful that 10-year Treasury yields could dip back below 4% once the conflict ends, considering that heavy corporate AI issuance is the primary factor keeping them elevated today. 

Trump and his top economic stewards have called on the Federal Reserve to lower rates, arguing the central bank is making a policy error by raising borrowing costs and mistaking supply-side growth for demand-side overheating. Officials remain hopeful that the Fed will listen. 

SEPTEMBER CPI

A hot September CPI report did little to take the pressure off the Fed to continue rate increases after a quarter-point hike in September, but the White House is highlighting more subdued underlying price pressures and anchored inflation expectations. 

Headline CPI climbed 3.7% while core rose 2.6% -- much lower than the equivalent PCE reading of 3.0%. At the same time, the Fed's alternative measures of underlying inflation run in a 2%-2.5% range and officials at both the central bank and the Trump administration see long-run inflation expectations as having stayed anchored. Traders moved to price about a 50% chance of a hike at the Oct 28 FOMC meeting, up from under 20%, after core CPI rose 0.33% on the month. 

Treasury Secretary Scott Bessent sees AI-driven investment raising potential growth to 3% and the supply-side gains as ultimately disinflationary, drawing a parallel with the 1990s when then Fed Chairman Alan Greenspan declined to tighten into a tech boom. Current Fed Chair Kevin Warsh is "well aware" of the productivity gains, Bessent said last month.

IMF Managing Director Kristalina Georgieva said Wednesday the U.S. cannot grow its way out of unsustainably high debt without reducing government ​spending and cutting deficits, a message echoed by Congressional Budget Office director Phillip Swagel. (See MNI INTERVIEW: Yield Jump, AI Bust Are Top Financial Risks-IMF)

Swagel is due to discuss the U.S. economic and budget outlook with MNI in a webcast on Oct 22. See INVITE: MNI Connect Livestream VC w/ CBO Phillip Swagel Oct 22.

MNI INTERVIEW: BOC Ready To Hike This Month If Needed- Stillo

Canada's central bank is prepared to start raising interest rates as soon as its Oct 28 meeting to prevent high energy prices from turning into sticky inflation, an ex finance official from the country's largest province told MNI.

"By January you'll see rates in Canada policy rates half point higher. Not the start of a tightening cycle, but return to a neutral stance," according to Tony Stillo, who was an Ontario forecasting manager and is now with Oxford Economics.

Monday's inflation report and the Bank of Canada's quarterly business and consumer surveys will be influential in the final decision, he said. That data is weightier than the last job report showing a drop in hiring he said, because it was led by education figures that have been irregular in the past. 

Governor Tiff Macklem's policy rate of 2.25% is half a point less than staff estimates of the neutral rate at a time when headline inflation has returned to a 3% pace. Those price gains are at the top of the Bank's target band and Macklem recently told MNI he must keep the inflation goal in focus even if the public is upset by any tradeoffs during a time of uneven economic growth. (See MNI INTERVIEW: Macklem-BOC Faces Tough Calls Ahead On Rates)

Recent concerns about diesel supplies add to risks Macklem has identified of inflation spreading beyond high energy costs as the Iran conflict continues, Stillo said. 

MODEST TIGHTENING

"That's the concern that I think the Bank is going to talk to, and say if it's sustained for longer they're worried about the persistence of that leading to more likelihood of pas-through to other core parts of the consumer basket," he said.

The Bank will hike further to 3.75% next year if Stillo's baseline prediction of fading energy prices isn't realized. "We could see the Bank moving to the top of the neutral range and perhaps higher. But we think that's less likely than just repositioning us to a neutral stance," he said. 

Recent Fed and ECB hikes aren't a direct reason for Macklem to follow suit, he said. But with the U.S. policy rate as much as 175bp higher than the Bank's, Stillo said further divergence brings Canada's dollar into play as another inflation source. "If they don't raise rates, you'd have a weaker Canadian currency, which could lead to higher import prices," he said.

The Canadian dollar is trading near a 19-month low of about CAD1.42 as of Thursday morning Ottawa time. It's been resilient to U.S. tariffs so far, down just 1% over the last year. 

Rate hikes will be modest rather than the jump seen following the pandemic because of a sluggish job market, last month's new round of U.S. tariffs, and population growth slowed by cuts to student and worker visas, Stillo said. "Slack in the economy and the labor market probably lessens the likelihood of a pass through that would be a problem," Stillo said. (See MNI INTERVIEW: Canada Investment Gloom To Outlast Trade Peace)