New Zealand set to stay in vanguard of tightening to cool prices

NEW ZEALAND is poised to keep spearheading a global tightening cycle to rein in spiralling inflation, even as signs emerge that its rapid-fire interest-rate increases are beginning to cool the economy.

The Reserve Bank (RBNZ) will deliver its fourth straight 50 basis-point rise at Wednesday's (Aug 17) policy meeting to take the Official Cash Rate (OCR) to 3 per cent, according to all 14 economists surveyed.

That would bring combined hikes since October to 2.75 percentage points, the most aggressive cycle since New Zealand pioneered inflation targeting over 30 years ago, and exceed the Federal Reserve's 2.25 points of increases.

"Successive large rate hikes mean that the gap between where the RBNZ is and where it needs to be has narrowed significantly," said Michael Gordon, acting chief economist at Westpac Banking.

That "could allow" the bank to return to normal-sized 25 basis-point moves, he said, while adding that Westpac expects the RBNZ will want to get "the job done quickly" rather than dragging it out.

New Zealand's economy is running near full capacity and the central bank has been driving up borrowing costs to try to keep inflation expectations anchored. The 10-month tightening cycle is now beginning to show effects on both the property and labour markets.

The question for investors is whether policymakers signal they will stick with outsized moves and deliver 2 more half-point hikes this year. Alternatively, they may take a cue from their Fed counterparts and flag the possibility of smaller increases.

The RBNZ was among the first to begin withdrawing pandemic-era stimulus and then shift to outsized moves earlier this year. That decision foreshadowed a similar response from central banks in the US, Australia and Canada.

New Zealand's frontline policy status has prompted investors around the world to closely watch the bank for an indication of what may unfold elsewhere.

SEE ALSO

New Zealand housing market decline gathers pace as prices drop

The RBNZ publishes Wednesday's decision at 2.00 pm local time and Governor Adrian Orr holds a press conference an hour later. The bank will also release new forecasts in its quarterly Monetary Policy Statement.

In May, the bank projected that the OCR would climb to 3.95 per cent in the third quarter of next year, implying a 4 per cent peak, with modest rate cuts then beginning in mid-2024.

Swaps markets are pricing in a 91 per cent chance of a half-point hike on Wednesday and a peak of 3.95 per cent for the OCR in the first quarter of 2023.

The rapid rate increases are beginning to show up in economic data:

• A housing market decline is gathering pace
• Unemployment has risen from a record low
• Business confidence has slumped; and
• The first drop in 2-year inflation expectations since mid-2020

As a result, economists now see a 1-in-3 chance of the economy tipping into a recession next year.

Last week, the market flashed a warning sign that the economy may turn down with the yield on benchmark 2-year bonds rising above the yield on 10-year notes for the first time since April 2015.

Still, the picture from the data is mixed. Inflation is running at a 32-year high of 7.3 per cent, soaring above the RBNZ's 1-3 per cent target, and wages are rising at the fastest pace in 14 years. The central bank has a dual mandate of employment and price stability and has said previously the labour market is too tight.

"Of course, the monetary policy takes time to feed through the economy," said Sharon Zollner, ANZ Bank's chief economist for New Zealand.

"But one thing's for sure: with inflation so high and broad-based, and wages rising fast, under a least regrets framework the RBNZ can't afford to make optimistic assumptions about the degree of effective monetary tightening it is delivering." BLOOMBERG