Markets latch on to Reserve Bank's projections for higher interest rates

Wednesday, 26 May 2021

The official cash rate has now been unchanged at 0.25 per cent for 14 months, after Reserve Bank governor Adrian Orr slashed it from 1 per cent in an out-of-cycle review in March last year.

Talk of interest rate hikes from the Reserve Bank has sent bond yields and the New Zealand dollar higher, despite efforts by governor Adrian Orr to talk up the uncertainties in the bank’s forecasts.

The Reserve Bank left the official cash rate (OCR) unchanged at 0.25 per cent as expected when it released its latest monetary policy statement on Wednesday.

But it said that “on current projections the OCR eventually increases over the medium term”.

The projections the Reserve Bank released alongside its statement would see the OCR start rising in the second half of next year, in line with most banks’ forecasts, and hit 1.75 per cent by mid-2024.

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The Reserve Bank hedged that by saying that was conditional on the economic outlook evolving broadly as anticipated, and again talked of the need for “considerable time and patience”.

Orr concluded a media conference by saying it too often fell on deaf ears that its projections were “highly conditional”.

“We are talking about the second half of next year. Who knows where we will be by then.”

But markets appeared to focus on the acknowledgement of the possibility of higher rates, with the New Zealand dollar climbing 0.8 US cents to US73.1c within two hours of the monetary policy statement.

The yield on 10-year government bonds jumped 8 basis points to trade at 1.91 per cent, close to a two-year high.

What does the official cash rate mean?

ANZ said the Reserve Bank’s projections were in line with its view that the central bank would start to lift in August next year but said “the risks are now skewed towards earlier”.

ASB said the mantra was still “wait and see”.

“We were a little surprised to see the bank be so forthcoming, with the publishing of an OCR track signalling rate hikes, and an acknowledgement that the OCR cannot remain at emergency levels forever,” economist Nathaniel Keall said.

“While we share the Reserve Bank’s view that the OCR will move up in 2022, their pace of hikes over the next few years is larger than what we envisage,” he said.

The Reserve Bank’s projections for growth, employment and inflation were all revised higher from February.

BNZ research head Stephen Toplis had forewarned ahead of the monetary statement that the Reserve Bank would be in a difficult position as it would be hard for it not to acknowledge developments but it would not want to trigger an over-reaction.

The Reserve Bank said the global economic outlook had continued to improve but, as expected, balanced its more positive scripted comments, saying the sustainability of the global economic recovery remained dependent on the containment of Covid.

The medium-term outlook for growth remained similar to the one the Reserve Bank last made in February, it said.

“Confidence in the outlook is rising as the more extreme negative health scenarios wane, given the vaccination progress globally,” it said.

“We remain cautious however, given ongoing virus-related restrictions in activity, the sectoral unevenness of economic recovery, and the weak level of business investment.”

It maintained its “wait and see” stance on the housing market, saying the extent of the dampening effect of the Government’s new housing policies on house price growth “and hence economic activity” would also take time to be observed.