When might interest rates fall?
Brad Olsen, New Zealand’s go-to bearer of economic news, is the chief executive and principal economist at Infometrics and an economics commentator. He gazes into his crystal ball to predict when interest rates might fall.
High inflation has seen interest rates increase to their highest since the end of 2008, with the official cash rate (OCR) at 5.50%. Higher interest rates force households to spend more on their borrowing costs and, therefore, less on other items and present a higher return for savings. All of these moves are designed to dampen economic demand, limit pricing pressures, and return inflation to the normal range of 1–3% per annum (pa).
Although correct in theory and practice, higher interest rates are hitting households hard. It’s working, with inflation having moderated from a peak of 7.3% pa in 2022 to 4.0% pa at the start of 2024. Yet the final push to bring inflation back towards the 2.0% midpoint target is proving frustrating, with domestically based inflation still sitting at a too-persistent 5.8% pa.
The pressure on households has everyone asking – both here in New Zealand and around the world – when interest rates will begin to fall. The good news is that they already are – ever so slightly. New special residential mortgage rates have edged down from the peak seen in November 2023, with the one-year fixed mortgage rate down from 7.30% to 7.07% and the two-year rate down from 7.01% to 6.75% pa. However, households are holding out for further drops once the OCR begins to fall.
Globally, interest cuts have commenced in some countries, but the pathway down has been signalled to be a slow one. Both the European Central Bank and the Bank of Canada have recently cut interest rates for the first time in this cycle, but expectations are for limited further cuts in 2024. The US Federal Reserve, the most influential central bank in the world, has continued to push out its expectations for interest rate cuts. At the start of 2024, three cuts were expected in the US. That’s now been trimmed down to just one.
Here in New Zealand, the call of ‘higher for longer’ has had to adjust to ‘survive to 2025’ as the Reserve Bank of New Zealand contemplates the right time to lessen economic pressures, but in such a way that a change doesn’t stoke inflation before it settles back into normal patterns. Given the persistence of inflation, expectations from some forecasters have shifted from August 2024 to November and now to February 2025. In some ways, early 2025 seems too late to begin cutting, given that interest rate decisions take 12–18 months to take full effect.
There’s a rising risk that we keep our foot hard on the brake too long and overdo the medicine. But the risk on the other side can’t be discounted either – after having inflation get out of control, it’s a tough battle to wrestle it back into order, and it’s unwise to let go before inflation is clearly close to and heading back into its cage.
The Reserve Bank will be wary of both when the right time is to cut and how it conveys any changes. Financial markets have already overreacted and continue to do so, with expectations of more and larger cuts still in 2024. Any early indications of a cut could spur too much excitement, so the Bank might well spring a cut as a surprise once it is confident it won’t scare inflation back to life.