ECONOMY

New Zealand expected to raise rates as inflation outstrips forecasts

The Reserve Bank of New Zealand is expected to raise interest rates on Wednesday to cool a hot economy and runaway housing market, in a decision that will be closely watched by central banks around the world.

Economists said the monetary policy decision would be a close call between a 25 basis points increase in the official cash rate, with more aggressive guidance for further rate rises, or a 50 basis points rise.

The RBNZ’s move is of international interest because it was one of the first central banks to tighten policy after the coronavirus pandemic struck — raising interest rates to 0.5 per cent last month — amid a global surge in inflation.

New Zealand’s central bank is unusual among its peers in that both inflation and employment are running at or above target levels, putting pressure on the central bank to reduce monetary stimulus.

“Recent data has reinforced that demand in the New Zealand economy is running hot and that inflation pressures are building,” said Michael Gordon, Westpac New Zealand’s chief economist, who expects a 25 basis point rise but added there was a material risk of a 50 basis point increase.

With New Zealand keeping Covid-19 cases near zero until recently, its labour market has not been badly disrupted by the pandemic. Third-quarter data showed the unemployment rate fell to a record low 3.4 per cent even as participation in the labour force rose to a high of 71.2 per cent.

The data, including for wage growth, was much better than the RBNZ’s forecast.

Meanwhile, third quarter inflation at an annualised rate rose to 4.9 per cent, well above the RBNZ’s forecast for 4.1 per cent. House prices climbed further in October and were up about 30 per cent year-on-year.

Andrew Ticehurst, Nomura Australia’s senior economist, cited a rise in longer-term inflation expectations along with other strong data as reasons for the RBNZ to raise rates by 50 basis points.

“The data suggest a clear risk of overheating,” Ticehurst said. Another reason for a bigger rise, he added, was that the next meeting would only take place in February.

“Because of the three-month gap between meetings, we see merit in a harder tap on the brakes, and one which would result in the cash rate finishing the year at a symmetrical 1 per cent,” Ticehurst said.

The RBNZ’s monetary policy is very stimulatory because its funding programme for banks, introduced late last year to deal with the impact of Covid-19, will continue until it ends in December 2022. Its asset purchases programme ended in July but it still holds all the bonds.

Jarrod Kerr, Kiwibank’s chief economist, said there was chance of a 50 basis points increase but he expected the RBNZ to achieve the same outcome through forward guidance via its “OCR track”, which provides a forecast of changes to interest rates.

“We expect the RBNZ to adjust their OCR track by pulling forward forecast hikes and pushing higher the end point,” Kerr said.

The rate decision will be accompanied by a quarterly monetary policy statement showing updated forecasts on the economy. In the last statement in August, the RBNZ projected the cash rate would rise to 2 per cent by September 2023 and stay near that level until September 2024.

Kerr expects the RBNZ to project a peak of about 2.7 per cent, while Westpac’s view is a peak of 3 per cent.

Gordon said that the risk of getting behind the curve could prompt the RBNZ to do more now. The advantage of a bigger move on Wednesday was that the RBNZ could avoid a higher peak in the cash rate, he said.

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