RBNZ hikes, gets hawkish

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ScreenHunter_2167 Apr. 24 08.26

By Leith van Onselen

The Reserve Bank of New Zealand (RBNZ) has once again hiked the official cash rate (OCR) by 0.25% to 3.00% on the back of growing strength in the New Zealand economy. From the Statement:

New Zealand’s economic expansion has considerable momentum, with GDP estimated to have grown by 3.5 percent in the year to March. Growth is gradually increasing in New Zealand’s trading partners, but inflation in those economies remains low. Global financial conditions continue to be very accommodating.

Prices for New Zealand’s export commodities remain very high, though auction prices for dairy products have fallen by 20 percent in recent months. Domestically, the extended period of low interest rates and strong growth in construction sector activity are supporting the recovery. Net immigration continues to increase, boosting housing and consumer demand. Confidence remains very high among households and businesses, and measures of investment and employment intentions are positive.

Spare capacity is being absorbed, and inflationary pressures are becoming apparent, especially in construction and other non-tradable sectors. The high exchange rate remains a headwind to the tradables sector, and along with low import price inflation has been holding down tradables inflation. The Bank does not believe the current level of the exchange rate is sustainable.

There has been some moderation in the housing market. Restrictions on high loan-to-value ratio mortgage lending are easing pressure, and rising interest rates will have a further moderating influence. However, the increase in net immigration is adding to housing demand.

Headline inflation is moderate, but inflationary pressures are increasing and are expected to continue doing so over the next two years. In this environment it is important that inflation expectations remain contained. To achieve this it is necessary to raise interest rates towards a level at which they are no longer adding to demand. The speed and extent to which the OCR will be raised will depend on economic data and our continuing assessment of emerging inflationary pressures, including the extent to which the high exchange rate leads to lower inflationary pressure.

By increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point, the Bank is seeking to ensure that the economic expansion can be sustained.

In its 13 March Monetary Policy Statement, the RBNZ raised its forward guidance on rate hikes, forecasting 1.25% of hikes before the end of this year and a further 1% of interest rate rises in 2015. If that guidance is maintained, then the OCR will be 4.0% by year’s end and 5.0% by the end of 2015, implying a variable mortgage rate of around 8%. The next full set of forecasts and commentary from the RBNZ, which is is due on 12 June, will elaborate on whether its forward guidance still holds.

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One thing that could pare back future rate hikes is the elevated New Zealand dollar (NZD), which the RBNZ has warned is not sustainable. To the extent that the NZD remains elevated, it could lead to lower inflationary pressure in the RBNZ’s outlook for interest rates (by lowering tradable goods inflation), taking some pressure off the need to hike rates.

It will be interesting observing the New Zealand housing market from here, which is now facing dual headwinds from the LVR caps and rising interest rates, offset by rising immigration.

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About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.