Interest rate rise inevitable, but Reserve Bank may not try to make big waves

Monday, 21 February 2022

It has been a long time between calls for the Reserve Bank since its last rate rise in November.

ANALYSIS: It is somewhere between being very likely and a near certainty that the Reserve Bank will raise the official cash rate by 25 basis points on Wednesday, according to economic forecasters.

The alternative scenario of a 50bp rise isn’t being completely ruled out by some bank economists, but would be a big surprise to most.

“You could absolutely justify 50bp from an economic point of view, but strategically and ‘PR’ wise there are better ways of achieving things,” ANZ chief economist Sharon Zollner says.

* Reserve Bank survey shows pundits increasingly divided over house prices and OCR

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

What does the official cash rate mean?

The expectation that the central bank will raise the OCR by 25bp at the meeting has been long-standing.

That means home-owners on fixed-rate mortgages should have relatively little to fear from the probable rate-change itself.

But BNZ research head Stephen Toplis says some home-owners on short-term fixed rates as well as floating rates could still feel a pinch.

“The ‘shorter’ you come, the more the floating rate impacts it. Out to one year to 18 months, you may still see some response to higher floating rates – it’s just it won’t be as much.”

Zollner says other mortgage rates could also move on Wednesday’s monetary policy statement, depending on whether and how the Reserve Bank chooses to tweak its previous projections of where the OCR is heading over the next few years.

At its November meeting, the Reserve Bank forecast the OCR would reach about 2.6 per cent by late next year before flattening off around that rate.

The Reserve Bank will update those expectations on Wednesday and Zollner expects it will raise its prediction of how high the OCR is likely to go over the forecast period to 3 per cent, bringing its forecast track more into line with ANZ’s own and other banks’ projections.

Toplis says markets have broadly priced-in a 3 per cent peak.

But Zollner says that should the Reserve Bank decide to show “a really aggressive” OCR track – for example by suggesting the OCR might still be climbing and heading above 3 per cent at the end of its new forecast period in three years’ time – then that would put upward pressure on mortgage rates.

What Reserve Bank governor Adrian Orr says about where rates are heading may be more significant than what he does.

Toplis believes the Reserve Bank “has to do something” that acknowledges inflationary and labour market pressures are greater than it had estimated.

The “gentler way of doing it” would be to change the OCR track, he says.

A much more hawkish stance from the Reserve Bank appears far from guaranteed, however, with some economists tipping upward pressures on the OCR to cool rapidly in the months ahead.

Capital Economics, for example, is tipping the Reserve Bank will be persuaded by falling house prices to end its tightening cycle as soon as August with the OCR at 2 per cent.

Ukraine is a long way away, but what happens there can be felt in financial and commodities markets around the world in seconds.

The central bank noted that a survey of top economists earlier this month showed top pundits were increasingly divided over the future level of house prices and the OCR, with forecasts for the OCR at the end of 2023 ranging from 1.5 per cent to 3 per cent.

Factors that might point towards the Reserve Bank opting to generate few waves on Wednesday include labour market figures coming in broadly in line with the central bank’s and market forecasts earlier this month.

Another is that after a long break between resets, the Reserve Bank would have another opportunity to raise the OCR a further 25 basis points to 1.25 per cent on April 13.

“There are so many moving parts, things could change very quickly,” Toplis says.

“At some point rising interest rates and a weakening in consumer and business confidence could see the economy slowing down a lot more than any of us are expecting, in which case that would also have another impact.”

An elephant which may be in the room or still hanging around the doorway by the time the Reserve Bank releases its monetary statement on Wednesday is the threat of a Russian invasion of Ukraine and subsequent severe global sanctions on the world’s 11th largest economy.

Zollner notes that for most people in New Zealand, Ukraine probably seems “quite far away”.

The immediate economic risks of an invasion include sharply higher prices for oil and some other global commodities, an energy crisis in Europe, and a share market slump.

Another is the danger that concerns about China's intentions towards Taiwan would come into much sharper focus, casting a cloud over New Zealand’s relationship with its biggest trading partner.

Toplis says financial markets are aware of the risks, which have helped explain rising oil prices and falling equity markets.

“But you need to see the ‘whites in the eyes’ of these things because over the last decade or so, we have had numerous issues to confront.”

“Barring all out war”, he would be very surprised if the situation in Ukraine affected what the Reserve Bank did on Wednesday.

“If something goes wrong, you are going to see a market response, there is no doubt about that. To the extent that it affects New Zealand, it is really hard to gauge.”