Series of 25 basis-point OCR hikes Reserve Bank's surest path back to normality

Friday, 13 August 2021

Reserve Bank governor Adrian Orr may have a harder job than usual steering bank’s monetary policy committee to a consensus.

ANALYSIS: The official cash rate has been sitting at a lowly 0.25 per cent for 17 months, but that is likely to finally change on Wednesday when the Reserve Bank releases its next monetary policy statement.

Most analysts, including economists at all the major banks, are tipping that Reserve Bank governor Adrian Orr will announce a 25 basis-point rise in the OCR to 0.5 per cent.

New homeowners shouldn’t be afraid of a 25bp hike as that has been fully priced into the market.

But few would be greatly surprised if the Reserve Bank pushed the OCR up 50 basis points to 0.75 per cent, which could send mortgage rates a little higher.

* Reserve Bank prepares to crack down on housing

* Market betting 'double-hike' in OCR to 0.75% next week more likely than no rise

It can’t be ruled out that the Reserve Bank will leave rates on hold.

Though that would certainly turn heads, some comments made by Orr could be interpreted as suggesting he is in less of a hurry rates than assumed.

A ‘triple hike’ to 1 per cent would be a massive shock.

Capital Economics analyst Ben Udy is among those tipping a 50bp rise.

He says the economy is “clearly overheating” and notes the bank’s mandates for both inflation and the labour market are now fulfilled – which appears almost undeniable.

New controls on mortgage lending that are in the pipeline could help dissuade the Reserve Bank from jumping to a ‘double-hike’ in the OCR.

But BNZ research head Stephen Toplis makes a strong argument that the Reserve Bank is likely to consider a double-hike unnecessary.

At the same time as making its rate call, the Reserve Bank will update its forecast for where it expects the official cash rate to go over the next thee years.

There is now an ocean of space for the bank to shift the forecasts it made in May, which envisaged no rise in the OCR until about September next year, with the rate not rising to 1 per cent until early 2023.

The only question is how far the bank goes in changing those expectations.

Toplis argues that if the Reserve Bank sees the need for more chill than a 25bp hike will deliver, it could achieve the same effect as a double-hike while giving itself more flexibility by opting for a more hawkish forecast than otherwise.

But exactly what a ‘hawkish’ forecast would look like in the current context is a bit hard to say.

What does the official cash rate mean?

Most banks expect the Reserve Bank to make additional 25bp rises on October 6 and November 24, which would take the OCR to 1 per cent with this week’s probable rise included.

If the Reserve Bank builds those hikes into its forecast, there is then the question of where the bank now sees the OCR heading early next year.

Regardless, the better part of valour may be discretion, for the Reserve Bank, as Toplis suggests.

The bank wants to be forward-looking when targeting inflation and employment.

But its huge misses underestimating growth and inflation and overestimating unemployment this year show it has no superpowers predicting the future.

Like the rest of us, it can only guess if the country will join Australia in succumbing to an outbreak of the Delta variant before vaccinations reach critical mass, or whether a stock market dive and slump in global demand may be around the corner.

Recent signs that inflation may be moderating in the United States, although weak, may be another development that tips the odds towards lesser action on Wednesday.

On the other hand, the Reserve Bank needs to be prepared for demand in the economy and domestic inflation to just keep compounding.

A frequent assumption is that the bank won’t want to embark on a series of rate rises only to have to quickly walk them back if circumstances change.

But responding to changing realities goes with the territory.

After emphasising the benefits of monetary policy certainty for the most of the past 17 months, Orr may choose to signal the bank now recognises a need to be much more light on its feet.

Also to be remembered is the Reserve Bank has tougher loan-to-value controls on mortgage lending and a new option to impose debt-to-income controls on loans in the pipeline, both of which could be viewed as a partial alternative to a larger rate hike.

All up, a 25bp rise and a warning that – barring fresh developments – there are many more such hikes queued up, seems likely to appeal as the safest path forward.