Global bond yields continued to move higher over the third quarter as central banks reiterated that interest rates would need to stay higher for longer to bring inflation back to manageable levels.
The move in bond yields put pressure on equity markets, which had, earlier in the quarter, risen as the probability of a soft landing grew. However, the hawkish central bank rhetoric saw equities close the quarter mostly lower.
Inflation remains front and centre, and while progress continues to be made, the recent rise in energy prices has caused some headline inflation readings to turn higher over the last month. Core inflation, which strips out the more volatile food and energy components, is still trending lower but remains well above levels where central banks are comfortable. This has put most central banks in wait-and-see mode, with risks skewed to the upside for further hikes from the Fed and the RBNZ.
In New Zealand, the outlook remains challenging, with the RBNZ likely to move in line with global central banks unless we see a sharp rise in unemployment. Any moves to ease monetary policy domestically before other central banks ease policy runs the risk of inflation turning higher. Households remain under pressure from higher mortgage rates which is weighing on retail spending, and although the housing market has stabilised it still faces downside risks if unemployment rises.
Our base case is that growth continues to slow but remains positive over the short term. Labour market demand continues to soften, partly due to easing consumption in the face of new headwinds, bringing it more in line with labour supply. Core inflation makes slow progress towards target, with central banks holding rates in restrictive territory. An extended period of tight monetary policy eventually weighs on growth enough to tip it into negative territory consistent with a mild recession.