RBNZ lifts the OCR to 5.25% in surprise move to combat cyclone ...

The Reserve Bank of New Zealand (RBNZ) has taken traders and economists by surprise by lifting the Official Cash Rate (OCR) by 50 basis points to 5.25% from 4.75%. 

This is the highest it has been since 2008, having increased 500 basis points in eleven hikes since August 2021; the fastest and largest monetary policy tightening on record. 

Economists and traders were almost universally expecting a 25 basis point increase in Wednesday’s monetary policy review, with some suggesting it would be the last this cycle.

The NZ dollar jumped almost 1%, from US63.0 cents to US63.7 cents, after the announcement and government bond yields also rallied.  

Wholesale interest rates have been declining throughout March as traders predicted overseas banking stress would deter the central bank from increasing rates as much as planned. 

The RBNZ’s monetary policy committee was not pleased with this development and opted for a larger lift in the OCR to push wholesale rates back to February levels.

Wednesday’s decision contrasts to the Reserve Bank of Australia which Tuesday opted to hold its cash rate at 3.6%, essentially pressing pause on its monetary policy tightening.

The inflationary impact of Cyclone Gabrielle also appears to have been a major factor in the larger-than-expected rate hike. 

“The recent severe weather events in the North Island have led to higher prices for some goods and services. This higher near-term CPI inflation increases the risk that inflation expectations persist above our target range”.

The committee said it expects the rebuild will boost economic activity, create demand for resources, and add more inflation pressure than assumed in the February Monetary Policy Statement.

In February, the RBNZ had forecast that lifting the OCR to 5.5% in the second half of the year would be enough to push inflation back into its 1% to 3% target range by September 2024. Consumers Price Index (CPI) inflation rose at an annual rate of 7.2% in the December quarter, according to Statistics NZ. The March quarter CPI reading is due out on April 20.

Lower wholesale lending rates and the cyclone rebuild was threatening this forecast and the central bank wants it back on track. 

Shock and Orr 

Economic pundits were expecting the RBNZ to talk tough on inflation but soften their views behind the scenes, as weaker economic data has begun to trickle in.

On Tuesday NZEIR’s quarterly survey of business opinion suggested the 0.6% fall in economic activity in the December quarter had continued through to March. Respondents said domestic trading activity had shrunk and investment intentions were at recessionary levels. 

However, the survey also showed the labour shortage was subsiding which could dampen inflationary pressures. Businesses reported being more concerned about making sales than finding staff for the first time since 2021. 

In a note prior to the announcement, ASB senior economist Mark Smith said the central bank would signal more rate increases despite signs of recession and capacity pressures easing.  

“The RBNZ is unlikely to rest on its laurels and is set to retain an explicit tightening bias given the still worrisome inflation outlook”. 

The monetary policy committee noted the weaker data but said inflation was “nevertheless still too high and persistent” and employment was beyond its maximum sustainable level.

Much of the decline in wholesale lending rates could be attributed to banking stress in the United States and Europe following the collapse of Silicon Valley Bank and the forced takeover of Credit Suisse. 

But again, the committee judged these conditions posed no risk to local banks and had not caused credit conditions to tighten. Instead, the decline in wholesale rates could cause consumer rates to fall, when the central bank wants them to stay at February levels. 

Cyclone inflation 

Households affected by Cyclone Gabrielle and the Auckland floods had a “short-lived” drop in spending with a relatively quick bounce back to pre-event levels. 

At the same time, the disruption has resulted in an increase in some prices — such as fresh vegetables. 

“Over the medium-term, the inflationary impacts of these events are likely to be somewhat larger than assumed at the time of the February Statement as more information has come to light about the scale of rebuild activity.” 

The bank does not think the New Zealand economy has entered a recession, saying that higher frequency indicators point to “modest yet positive growth over the first quarter of 2023”.

Also factored into the decision was possible fiscal spending. The current projection assumes Government consumption and investment will fall as a share of the economy in coming years.

“However, members viewed the risks to inflation pressure from fiscal policy as skewed to the upside, particularly given the ongoing demand for government services in an environment of rising costs of provision. 

The economic impact of the Government response to recent severe weather events will depend on the scale of damage, fiscal reprioritisation decisions, timing of activity and how Government spending is funded”.

All of this added up to the monetary policy committee determining that a further increase in the OCR was required to ensure core inflation and expectations begin to fall. 

The members were comfortable that current lending rates faced by businesses and households would be enough to do the job, but the lower wholesale rates posed a threat. 

“As a result, a 50 basis point increase in the OCR was seen as helping to maintain the current lending rates faced by businesses and households, while also supporting an increase in retail deposit rates”. 

The central bank said it was expecting to see domestic demand and inflation to “moderate,” and gave no indication as to whether it expected to lift rates any further. 

“The extent of this moderation will determine the direction of future monetary policy.”