This opinion piece was first published on Stuff on 2 October 2023.

There’s no expectation that the Reserve Bank will change the official cash rate (OCR) at this week’s Monetary Policy Review, especially given that it takes place just 10 days out from the election. The Bank hasn’t changed the OCR at the last review before an election since 2008, when the Global Financial Crisis was a far bigger issue than worries that a shift in monetary conditions might change voters’ minds one way or the other.

Despite the likely lack of action this week, the Bank is drawing close to a critical juncture for monetary policy. Since it first signalled the OCR was on hold back in May, there has been a divergence between forecasters about whether the current rate of 5.50% is the peak for the OCR, or whether rates would rise further this year. If rates are to rise again before the end of 2023, the only opportunity after this week’s review is on 29 November. And as it stands, there’s a mounting risk that the Bank opts to tighten monetary conditions further.

At August’s Monetary Policy Review, the language used by the Bank contained no real indication of whether it was starting to lean more towards the need for another rate rise or not. However, the accompanying interest rate projections implied that the probability of the OCR rising again had increased to about 35%. That figure indicates another rate rise in November is far from guaranteed, and it was viewed by the Bank in August as the less likely option.

In its battle against inflation, the Bank has several encouraging signs, including ebbing international inflationary pressures, supply chains and international shipping that are functioning much more like normal than they were during the pandemic, less stretched capacity in the construction sector, and improvements in the labour supply thanks to the migration influx and access to foreign workers.

But that good news is tempered by other signs that inflation could stay elevated for longer than the Bank’s most recent forecasts, which showed it getting back inside the 1-3%pa target band by September next year. Diesel prices have risen 41c/L since mid-July as international oil prices have surged, compounding the effect of the reinstatement of full road user charges on transport costs. Economic growth, although somewhat patchy, has been stronger than forecast, with persistent pockets of demand potentially maintaining some upward pressure on prices. The labour market has, so far, absorbed all the extra workers coming into the country, and shown little sign of much easing in associated demand or cost pressures. The housing market has clearly bottomed out over the last three months as well, which should be starting to ring some alarm bells given that housing is still less affordable than it was pre-pandemic.

Those indicators could lead to a signal from the Bank in this week’s statement that the chances of a rate hike in November have risen further. That prospect would be concerning for mortgage holders, who already face the highest one- and two-year mortgage rates when refixing since at least 2010.

It’s becoming increasingly clear that talk of interest rates peaking might have been premature – much to everyone’s frustration. International borrowing costs have pushed up mortgage rates over recent months, even as the OCR has been on hold, and a raise to the OCR in November would add even more pressure to mortgage rates.

However, there’s more to be worried about than another quarter percentage point increase in the OCR before the end of this year. The OCR has already been lifted by 5.25 percentage points since late 2021. If, by November, the Bank concludes that it has not already done enough to bring inflation back under control, it is difficult to see how another quarter percentage point rise will be sufficient to turn the battle in the Bank’s favour. Firstly, the interest rate increases to date will continue to push up households’ average mortgage payments for another year as previous fixed loans come up for renewal. Existing higher rates will have a much larger effect on debt-servicing costs than another solitary increase would. And against that backdrop, a single rate rise would suggest a much greater degree of fine-tuning is possible when setting monetary policy than can realistically be expected.

The question then becomes, not whether the peak in the OCR is 5.50% or 5.75%, but whether the peak is 5.50% or somewhere in the 6.00-6.50% range. If, in November, the Reserve Bank judges that more tightening in monetary conditions is necessary, then how many further interest rate rises does it follow up with in early 2024? And almost as importantly for households, how much longer might that extended tightening programme delay any interest rate relief? If the Bank is still lifting interest rates in May next year, then it is unlikely to be reversing those cuts before the end of 2024. Unless a sudden downturn appears in the New Zealand economy within the next eight weeks, the squeeze of higher mortgage payments on household budgets could continue for a lot longer yet.