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Market shows promising reaction to central bank's dovish pivot

After a long period of elevated interest rates, New Zealand's equity market now stands at the beginning of a rate-cutting cycle, with the Reserve Bank of New Zealand (RBNZ) having lowered the Official Cash Rate (OCR) at its last two monetary policy meetings. After hiking the OCR to 5.5% in May 2023 and then standing pat for over a year in order to curb inflation, the RBNZ started the cutting cycle with a 25-basis point reduction to 5.25% in August 2024. That was followed by a more substantial 50-basis point cut in October 2024, bringing the OCR to its current level of 4.75%. The RBNZ's shift to a more dovish stance already appears to have buoyed New Zealand's equities at this early stage of the cycle, with examples including signs of strength in the retirement village and rental sectors. The market as a whole has been delivering strong returns of late, with the S&P/NZX 50 Index of New Zealand's largest companies by market capitalisation having risen by approximately 16% towards the end of October 2024 compared to about 12 months before. At the same time, data show that New Zealand's consumers price index (CPI) eased to an annual rate of 2.2% in the September 2024 quarter1, putting it only slightly above the mid-point of the RBNZ's target range of 1-3%.

Lower interest rates and softer CPI seen favouring equities

We view both the lower OCR level and the softer CPI reading as signs of a more favourable environment for the stock market going forward. In our view, equities generally respond well to low interest rates for several reasons. The first of these is the lower cost of debt interest as it enables companies to get some relief on fixed debts as their debt rolls over. Secondly, given that consumers also benefit from relief on debt from lower rates, we feel that these cuts in the OCR are likely to make consumers more confident about spending. The third potential benefit is related to investment allocation decisions. We think that investors seeking yields are likelier to move their money out of low-risk vehicles such as term deposits and into dividend stocks when the OCR is on a downward trajectory. This is because lower interest rates tend to encourage investors to take on more risk in order to achieve similar levels of income. In our opinion, these factors are all likely to be positive for equities.

Outlook may be brightening following weakness of last reporting season

New Zealand's last earnings reporting season, which occurred around August, reflected a low point in the economic cycle, with companies reporting weak results and some firms missing earnings targets. Even so, although the October ANZ Business Outlook survey2 painted a picture of continued pain in some areas, it also provided signs of a brightening outlook. For example, companies reported depressed levels of business activity and employment, but forward-looking confidence indicators in the survey were brighter, with business confidence hitting a fresh 10-year high. In our view, this growing optimism is a product of New Zealand's lower interest rate environment.

1 https://www.stats.govt.nz/information-releases/consumers-price-index-september-2024-quarter/
2 https://www.anz.co.nz/about-us/economic-markets-research/business-outlook/