Reserve Bank makes it five-from-five for 50 point Official Cash Rate hikes

The Reserve Bank (RBNZ) has raised the Official Cash Rate by 50 basis points to 3.5% - but appears to have come very close to making a bigger hike.

It is the fifth consecutive 50 point rise as the RBNZ attempts to get on top of inflation that hit an annual rate of 7.3% in the June quarter.

The OCR is now at its highest level in over seven years, while the five consecutive 50 point rises are unprecedented.

But in what was quite a 'hawkish' statement the RBNZ said its Monetary Policy Committee had given serious consideration to hiking the OCR by 75 points this time around.

"Some members [of the committee] highlighted that a larger increase in the OCR now would reduce the likelihood of a higher peak in the OCR being required," the RBNZ said.

"Other members emphasised the degree of policy tightening delivered to date. Members also noted the lags in monetary policy transmission and a slow pass-through to retail interest rates. On balance, the committee agreed that a 50 basis point increase was appropriate at this meeting."

And in a further hawkish signal in the notes from the MPC meeting, the RBNZ said committee members noted the strong funding position of banks and that as a result, recent increases in wholesale interest rates "have yet to be fully reflected in retail interest rates".

"However, wholesale funding costs are rising and bank funding conditions are expected to become less accommodative. The Committee expects that higher wholesale interest rates will be reflected in higher retail interest rates, particularly deposit rates, as banks compete for funding."

Banks will likely see this as a green light for further rate rises sooner rather than later.

There was also reference to the NZ dollar, which has weakened considerably in recent weeks in the face of a very strong American currency.

The MPC noted that higher global interest rates and increased risk aversion in global markets "have placed downward pressure on the New Zealand dollar".

"Members believed that this would contribute toward a rebalancing of New Zealand’s current account over the long-term. However, a lower New Zealand dollar, if sustained, poses further upside risk to inflation over the forecast horizon."

After the OCR announcement was made the Kiwi dollar rose to about US57.75c from US57.3c prior.

The OCR has now been lifted some 325 basis points in the past 12 months, after being on an emergency setting of just 0.25% for about a year and a half after the onset of the pandemic.

The latest OCR review was not accompanied by a Monetary Policy Statement (MPS) - the next one of these will be issued on November 23 - so, the forecasts from the August MPS were not updated as such. Those forecasts (page 45) suggested an OCR peak of just over 4% by the middle of next. Significantly, the RBNZ made no reference at all to those forecasts.

That fact, plus other comments that were made in the RBNZ's statements on Wednesday would do little to dampen market speculation that a higher OCR than 4.0% will be needed.

More recently, the wholesale interest rate markets have been 'pricing in' a peak OCR of 4.75%. ANZ economists have forecast a 4.75% peak. Most other economists are leaning towards a top of 4.25%, though Westpac's economists recently raised their peak pick to 4.50%. 

Westpac's acting chief economist Michael Gordon said the record of the MPC meeting was "unusually explicit" in noting that the committee debated between a 50 or a 75 basis point hike. 

"The latter was argued on a ‘stitch in time’ basis: a larger increase now could reduce the risk of a higher peak in the overall OCR cycle. This suggests that the RBNZ is now eyeing a considerably higher peak than the 4.1% from its August projections," Gordon said. 

"Today’s 50bp increase was widely expected, and the implicit signal of a higher OCR peak was broadly in line with what we expected. We recently revised up our OCR forecast to a peak of 4.5% by next February." 

This is the statement from the Reserve Bank:

The Committee agreed it remains appropriate to continue to tighten monetary conditions at pace to maintain price stability and contribute to maximum sustainable employment. Core consumer price inflation is too high and labour resources are scarce.

Global consumer price pressures remain heightened. The global demand for goods and services is exceeding supply capacity, putting upward pressure on prices. Food and energy prices are being particularly exacerbated by the war in Ukraine.

A recent decline in oil prices and an easing in some supply-chain constraints have seen headline inflation measures fall in some countries. However, core measures of inflation have risen and persist. Central banks are tightening monetary conditions, implying a weaker growth outlook for New Zealand’s trading partners.

In New Zealand, the level of domestic spending has remained resilient to date, in the face of slowing global growth and higher domestic interest rates. Employment levels are high, and household balance sheets remain resilient despite the fall in house prices.

New Zealand’s productive capacity is still being constrained by labour shortages and wage pressures are heightened. Overall, spending continues to outstrip the capacity to supply goods and services, with a range of indicators continuing to highlight broad-based pricing pressures.

Committee members agreed that monetary conditions needed to continue to tighten until they are confident there is sufficient restraint on spending to bring inflation back within its 1-3 percent per annum target range. The Committee remains resolute in achieving the Monetary Policy Remit.

Summary of Monetary Policy Committee meeting:

The Monetary Policy Committee discussed developments affecting the outlook for inflation and employment in New Zealand. Inflation is currently too high and employment is beyond its maximum sustainable level. The Committee agreed to continue increasing the Official Cash Rate (OCR) at pace to maintain price stability and support maximum sustainable employment.

The Committee discussed recent international economic developments. Inflation remains high globally. Headline inflation has declined slightly in some countries, but core measures of inflation have proved more persistent. Recent indicators suggest the global growth outlook has weakened, in part due to tighter global financial conditions. In Europe, the war in Ukraine continues to pose downside risks to growth and upside risks to inflation. In China, containment of COVID-19 continues to adversely impact activity and there are financial stresses emanating from the property sector.

The Committee observed that global sovereign bond yields have increased significantly, consistent with a repricing of expectations for central bank policy rates. Some members believed that simultaneous and fast-paced monetary tightening in multiple countries was increasing downside risks to global growth. Members noted that large movements in wholesale interest rates and exchange rates were causing a deterioration in financial market liquidity, which can exacerbate market volatility. 

Higher global interest rates and increased risk aversion in global markets have placed downward pressure on the New Zealand dollar. Members believed that this would contribute toward a rebalancing of New Zealand’s current account over the long-term. However, a lower New Zealand dollar, if sustained, poses further upside risk to inflation over the forecast horizon.

The Committee discussed recent developments in the domestic economy. New Zealand GDP in the June quarter rebounded broadly as expected. This was supported by a resumption in international tourism following the reopening of New Zealand’s borders, and an increase in domestic activity following the relaxation of pandemic restrictions. Other more recent indicators suggest that domestic activity in the September quarter may have been slightly stronger than previously assumed. Consumption remains resilient overall, but spending on durable goods, which may be more sensitive to interest rates, has continued to decline.

Household balance sheets are resilient despite recent declines in house prices. Members agreed that falling house prices and declines in other asset prices will negatively impact household consumption. Members noted that household debt servicing costs were rising and had further to increase on average as more fixed-rate mortgages are reset at higher interest rates. The impact of higher debt servicing requirements are an important channel of monetary policy transmission.

The Committee noted recent survey data showed that for businesses, cost pressures and labour scarcity remain the primary concerns. The construction industry faces ongoing capacity constraints. Building consents remain near historic highs, driven by growth in multi-unit dwellings, although there is uncertainty about the construction pipeline going forward.

The Committee agreed that the labour market remains very tight. Net migration remains negative and is yet to provide any sustained recovery in external labour supply. Members discussed the likelihood of further upside wage pressure given lags in the wage setting process. Some members noted that there may be changes in wage setting behaviour in an environment of higher headline inflation.

The Committee discussed domestic financial conditions. Members noted the strong funding position of banks and that as a result, recent increases in wholesale interest rates have yet to be fully reflected in retail interest rates. However, wholesale funding costs are rising and bank funding conditions are expected to become less accommodative. The Committee expects that higher wholesale interest rates will be reflected in higher retail interest rates, particularly deposit rates, as banks compete for funding.

The Committee discussed the pace and extent of monetary tightening required. Members agreed that the OCR needed to reach a level where the Committee could be confident it was sufficient to maintain expectations of low inflation in the longer term and bring consumer price inflation to within the target range.

The Committee considered whether to increase the OCR by 50 or 75 basis points at this meeting. Some members highlighted that a larger increase in the OCR now would reduce the likelihood of a higher peak in the OCR being required. Other members emphasised the degree of policy tightening delivered to date. Members also noted the lags in monetary policy transmission and a slow pass-through to retail interest rates. On balance, the Committee agreed that a 50 basis point increase was appropriate at this meeting.

On Wednesday 5 October, the Committee reached a consensus to increase the OCR to 3.5 percent from 3 percent.

The August Monetary Policy Statement is here.