Oil shock, softer economy: why holding the OCR may be the bigger risk

What an oil price shock means for the OCR, inflation, and the wider New Zealand economy

The Reserve Bank has indicated it should hold the OCR.

Our view, set out in a recent research paper submitted to the Reserve Bank, Treasury and the Minister of Finance, is that whilst at least they are not indicating any rise in the OCR anytime soon keeping the OCR at 2.25% may be a wrong call. Reducing it now makes sense.

You can download and read the full paper here: New Zealand Oil Price Shock Response Paper

Not because inflation has disappeared. It hasn’t. But because the current problem is not a classic burst of domestic overheating. It is an imported oil shock hitting an economy that was already soft underneath.

That is the heart of it.

When oil jumps, headline inflation rises. Petrol gets dearer. Freight costs lift. Business margins get pinched. Household budgets get squeezed. But none of that means New Zealanders will suddenly start spending too freely.

It means a vital imported input has become more expensive and the pain is flowing through the economy.

Our paper argues this is primarily a contractionary shock, one that weakens real spending power even as it pushes some prices higher.

And that is precisely why simply sitting still on the OCR can be a policy mistake.

The OCR is built to lean against demand driven inflation. It works when the economy is too hot, credit is flowing too freely, and spending is pushing beyond capacity. But when the inflationary impulse is coming from offshore oil markets, holding monetary settings tighter than necessary does not lower the price of crude, reopen shipping routes, or shave cents off the petrol pump.

It just leaves households and businesses carrying the full weight of the shock for longer.

It is a bit like watching someone struggle uphill with a full pack, then someone else added ankle weights to them. You could either just keep watching as they struggle even more or decide to help them immediately by lightening the full pack to some degree.

The economy was not running hot in the first place

When the starting point is already fragile it becomes even more important to support the economy.

Our submission notes that New Zealand entered this shock with an output gap of around negative 1.5 percent of potential GDP, unemployment at 5.4 percent, and two year inflation expectations at 2.37 percent.

Core and demand driven inflation were already easing back toward target. In other words, this was not an economy bursting with excess demand. It was an economy still trying to get back on its feet.

That backdrop changes the policy question.

If domestic demand was roaring, credit growth was surging, and housing was back in a broad speculative rush, then holding the OCR would be easier to defend. But that is not the picture in front of us.

The risk here is that policymakers focus on the visible rise in headline CPI and overlook the quieter damage happening underneath it: weaker discretionary spending, delayed business investment, softer hiring intentions, and a recovery that loses momentum… again.

Our paper also points to another issue that deserves more attention. Some of the inflation pressure already in the system has come from administered prices such as council rates, electricity, and insurance.

These are not the sort of things the OCR can neatly bring down either. Raising or holding monetary pressure against those price rises does not solve them. It simply pushes harder on the rest of the economy.

Why property investors should care

This is not just a central bank debate but important for property directly.

A poorly calibrated response to an oil shock does not stop at the fuel pump. It runs through confidence, turnover, construction, rental supply, and financing conditions.

If households feel poorer and businesses become more cautious, housing activity stays subdued. Developers hesitate. Builders get less work. Investors sit on their hands longer.

A market recovery that was trying to gather itself can end up bogged down again.

That’s critical because housing is tightly woven into the wider economy, whether people like that fact or not.

Our paper makes the point that residential property investors are not simply trading existing homes between one another. They are also a major source of spending on new builds, maintenance, and improvements across the housing stock.

The recent Infometrics research cited in the submission estimates that residential property investors contributed about $24.8 billion in GDP and supported around 126,000 full time equivalent jobs, with new build investment alone sustaining more than 100,000 jobs across the economy.

That does not mean every form of investor activity is equally helpful. It does mean broad brush policy settings can do far more collateral damage than many people assume.

The stronger policy mix is not hard to see

This is where the Staircase submission takes a more practical route than the usual all or nothing debate.

The paper argues that if oil prices remain elevated, domestic demand keeps weakening, and inflation expectations stay anchored, then the case shifts toward a modest OCR cut rather than a hold.

Specifically, it recommends an initial 25 basis point reduction to 2.00 percent, with any further easing conditional on the data.

That is only one side of the framework though.

At the same time, the paper argues that housing credit settings should be used more actively to stop easier money spilling into leveraged demand for existing homes.

That means tighter investor specific LVR and DTI settings, plus a modest tightening in owner occupier DTI settings, while leaving owner occupier LVR settings unchanged.

This is a much cleaner policy split.

Support the wider economy where it is under pressure. Keep firmer guardrails around leverage where it can do damage.

Those two ideas are not in conflict. They actually complement each other.

From a property market perspective, that makes far more sense than pretending one blunt setting can do every job at once.

Protect supply, not speculation

One of the best parts of the paper is that it does not treat all housing lending as though it has the same effect.

New builds, construction loans, and social housing related lending should remain exempt from tighter temporary settings, according to the submission.

That is not a small technical point tucked in the back pages. It is central to the logic.

If the goal is to stop cheaper money fuelling more speculation in existing stock, it makes little sense to also choke the forms of lending that add supply, support jobs, and ease future rental pressure.

Trying to crack down on speculation by squeezing all housing activity is like trying to stop one room overheating by cutting power to the whole house.

New Zealand has made enough of those sorts of policy mistakes already.

Monetary policy should not be left to do the whole job

The paper also argues for temporary, targeted fiscal support alongside monetary and macroprudential changes. Measures such as fuel excise relief and direct cost of living support are better suited to the immediate hit landing on household budgets.

If the pressure arrives first through the petrol bill, then part of the response should meet people there.

That is a more intelligent use of the policy toolkit.

One instrument helps cushion the broader economic slowdown. Another helps stop leverage running ahead in housing. Another helps soften the immediate cost shock.

Each tool should be aimed at the channel it can actually influence, rather than asking the OCR to do everything badly.

What this means now

From a Staircase perspective, the issue is not whether the oil shock lifts prices in the short term. Of course it does.

The issue is whether that automatically makes a hold the safest response.

Our paper argues it does not. In current conditions, a hold risks leaving the economy exposed to the full contractionary force of imported energy prices at exactly the wrong time.

The stronger response may be a measured OCR cut, tighter credit guardrails where speculation is the risk, preserved exemptions where supply is the goal, and temporary fiscal relief where the pain is immediate.

For property investors, developers, and anyone watching the cycle closely, that is the key takeaway.

An oil shock can push inflation up while pushing growth down.

And when that is the mix in front of you, standing still is not always the cautious option.

It could be a decision that risks allowing more of the damage to run through the economy than necessary, and for a country already trying to rebuild momentum, that is a risk New Zealand cannot afford.