Take Five: Key questions on Reserve Bank's rate hike answered

Wednesday, 13 July 2022

What does the official cash rate mean?

The Reserve Bank kept its blinkers on inflation by raising the official cash rate by 50 basis points at its monetary policy review on Wednesday, taking the rate from 2% to 2.5%.

Economists had been looking for any hints from the Reserve Bank that growing fears of an economic downturn might deflect it from its newly-energised fight against inflation.

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* Bankers watching for any sign of recession nerves from Reserve Bank on Wednesday

So what did the Reserve Bank say?

The central bank very briefly and dryly acknowledged what it described as “emerging medium-term downside risks to economic activity”.

But its overall message was clear: that it was keeping its focus very firmly on bringing down inflation to back within its 1% to 3% target band.

The Reserve Bank described inflationary pressures as “pervasive”, using language and a tone that banks ASB and ANZ viewed as being more or less unchanged from its hawkish monetary policy statement in May.

It also said it was “broadly comfortable” with its May forecast which would see the OCR peak at 4% during the second half of next year.

Were there any surprises?

No.

Economists sometimes differ in their predictions of what the Reserve Bank will do to the OCR and occasionally even the majority have been wrong-footed by the bank.

Reserve Bank governor Adrian Orr delivers the official cash rate. (File photo)

But not this time, when they and the Reserve Bank all seemed to be on the same page.

That is not to say every senior economist thinks a “double hike” of 50 basis points was actually necessary right now, looking at the current economic data, but they all expected it.

It is no surprise either that the Reserve Bank did not make much of a nod to the growing speculation around the world and in New Zealand that recessions may be in the pipeline.

The assumption has been that whatever concerns members of its monetary policy committee may privately harbour about the economic outlook, they would not want the Reserve Bank to show any public sign of losing its new, narrow focus on strangling inflation until they were more confident that it was “job done”.

Reserve Bank governor Adrian Orr discusses the risk of a recession in May.

What does this mean for savers and borrowers?

Nothing very dramatic.

Mortgage holders probably should not be too concerned about the rate rise, which appears to have been fully priced into longer-term mortgage rates.

The New Zealand dollar and swap rates initially eased a little, presumably because of the reference the Reserve Bank made to emerging downside economic risks.

But the dollar, at least, snapped back as a consensus emerged on Wednesday afternoon that the real message from the Reserve Bank was that it was sticking to its guns in the fight against inflation.

Retail interest rates could continue to shift a little over the coming hours, days and weeks as forecasters digest the Reserve Bank’s commentary and new economic data, and make their next bets.

Will the rate rise work in bringing down inflation?

Tough question as there are lots of moving pieces in that puzzle but the conventional view is that it ought to have some effect.

The current bout of inflation is largely blamed on supply chain difficulties caused by Covid and Russia’s war on Ukraine, and by previously low interest rates and the $53 billion of liquidity pumped into the financial system through the Reserve Bank’s $53 billion quantitative easing programme.

It is sometimes noted that interest-rate hikes won’t do anything to ease the supply chain problems that are one cause of inflation.

But reducing demand in the economy should generally lead to lower price rises, regardless of the cause of inflation, at least in the short term.

What will the next move from the Reserve Bank be?

The Reserve Bank will have another scheduled opportunity to reset the OCR in five weeks when it issues its next monetary policy statement on August 17.

Most economists are expecting it to hike the OCR by a further 50bp to 3% then.

But although it is a short gap between resets, a lot of important data will be released between now and then.

In particular, Stats NZ will release the June-quarter inflation data on Monday.

If it shows annual inflation still rising, the assumption may harden that the Reserve Bank will lift the OCR by a further 50bp next month.

But if the June-quarter data suggests annual inflation has passed its peak, then a smaller 25bp rise and an earlier change in tone from the Reserve Bank may become more likely.

The June-quarter labour market figures on August 3, which could see official unemployment setting (or retreating from) a recent record, could also easily tip the balance.