NZ Reserve Bank tipped to raise official cash rate to highest level since 2016

Friday, 20 May 2022

The Reserve Bank has been hiking interest rates aggressively to combat inflation.

The Reserve Bank will release its second monetary statement for the year on Wednesday.

Bank economists universally expect it will announce another hike in the official cash rate (OCR).

But there will be a lot more to look out for, especially as the statement will come just days after the Government’s big spending Budget.

These are likely to be six of the hottest topics on Wednesday.

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The size of the OCR hike

Most bank economists expect the Reserve Bank will announce another “double hike” in the OCR, raising it from its current level of 1.5% to 2%, which would be the highest it has been since September 2016.

But bond market investors have been pricing in a small chance that the central bank will opt to raise the rate by only 25 basis points to 1.75%.

The rate hike should flow through quickly to floating and short-term mortgage rates, and perhaps to bank deposit rates though not, recent history suggests, in equal proportion.

The bank’s future interest rate forecasts

Reserve Bank governor Adrian Orr not buying into 'regret analysis' in May.

The Reserve Bank reviews the OCR about every seven weeks but it only issues a new monetary policy statement at every other review.

This is one of those more important meetings.

The statement will update its chart of roughly where the Reserve Bank expects the OCR to be over the next three years.

In it last monetary statement in February, the Reserve Bank forecast the OCR would rise to about 2.2% in December and would climb above 3% in September next year, topping out at about 3.4% in September 2024.

It is highly likely to change those forecasts on Wednesday and no doubt will do so again when it releases its next monetary policy statement after that in August.

But the forecasts can still immediately affect mortgage rates, as banks use them to help decide what rates they should be charging now on longer-term fixed mortgages and term deposits.

There is still an unusual level of disagreement between economists about how high interest rates are heading over the next year or two.

ASB senior economist Mike Jones expects the OCR will peak during this cycle at 3.25% and that the Reserve Bank’s forecast may this time show light at the end of the tunnel, with projections for falling rather than flat-lining rates at the end of its forecast period.

But BNZ research head Stephen Toplis says swap-rate pricing on financial markets suggests investors are expecting it to peak higher, at about 3.75%.

The Reserve Bank’s new forecasts are likely to be closely watched.

What reasons the Reserve Bank gives for its rate decision

In February, the Reserve Bank tipped the OCR would not breach 2% until towards the end of this year.

Homes used to cost a lot less, but in previous decades home loan interest rates were much higher. Home loans rates are however on the rise as the Reserve Bank Te Pūtea Matua has been raising the official cash rate to fight inflation.

So if it raises the rate to 2% at this week’s meeting, one question will be “why”.

Arguably, most economic data since February has landed around where the Reserve Bank expected.

Recent drops in house prices also suggest that rising interest rates are quickly having their intended effect.

As ANZ put it, “the Reserve Bank is shooting the housing market in the back” with its OCR hikes.

So has the Reserve Bank detected new inflationary dangers ahead, or may it just be thinking that it may as well as get the bulk of the hikes that it expects to make under its belt now?

It may shed more light on its thinking on Wednesday.

Its updated economic forecasts

The Reserve Bank will also update its forecasts for inflation, unemployment and economic growth on Wednesday.

The Treasury cut its growth forecasts in the Budget, predicting the country’s GDP (gross domestic product) would be only 9.3% higher in the year to June 2026 than it will be this year.

As recently as December, it had been predicting the economy would be 12.2% larger by the end of that forecast period.

The Treasury also forecast unemployment would rise to 4.8% in 2025, a percentage point higher than its previous projections, and that inflation would be more stubborn than the Reserve Bank’s current predictions.

The Reserve Bank is likely to shift its forecasts closer to those of the Treasury on Wednesday but any discrepancies will be pored over by economists for signs the Reserve Bank may be unduly hawkish or doveish.

The language that Reserve Bank governor Adrian Orr uses to describe current developments will also help set the scene for the banks’ response to its monetary statement.

Will he see signs that the housing market downturn is gathering pace or that the labour market is cooling?

Will he back the Treasury’s assessment that the short-term economic outlook, at least, remains robust?

Political ammunition for National or Labour?

Coming so soon after the Budget, it is not just economists who will be analysing the Reserve Bank’s every word.

Last month, Orr gave ammunition to the National Party by suggesting government spending could be more targeted.

So what, if anything, will the bank have to say about the inflationary implications of last week’s big spending Budget and, in particular, the $350 cost of living payment being dished out to most wage earners?

Will the bank suggest the Government’s fiscal policy and its own bid to put a lid on inflation dovetail, or may there be any small signs of a wedge developing?

ANZ chief economist Sharon Zollner has suggested it might be possible to draw a straight line between the Government’s spending plans and the Reserve Bank’s actions.

“With economic capacity already stretched, the Reserve Bank might need to ‘make room’ for government spending by inflicting higher interest costs on businesses and households,” she said after the Budget on Thursday.

It is the perception of that sort of trade-off that the Beehive won’t want to hear further articulated during discussion of the Reserve Bank’s monetary policy statement on Wednesday.

The Government won’t want homeowners to feel they may pay for those $350 cost-of-living hand-outs by way of higher mortgage repayments, after all.