New Zealand’s central bank raised interest rates for the second time in two months and signalled it will need to tighten policy more quickly than previously expected to contain the inflation.
The Reserve Bank’s Monetary Policy Committee lifted the official cash rate by a quarter percentage point to 0.75% on Wednesday, as expected by most economists. New forecasts published by the RBNZ show the cash rate rising to 2% by the end of 2022, a year sooner than projected just three months ago.
“Capacity pressures have continued to tighten” and “employment is now above its maximum sustainable level,” the RBNZ said. “A broad range of economic indicators highlight that the New Zealand economy continues to perform above its current potential.”
New Zealand is at the forefront of global stimulus withdrawal as policy makers start to move away from the view that faster inflation caused by supply chain disruptions during the pandemic is transitory. But the kiwi dollar and bond yields fell as some traders had wagered on a more aggressive 50 basis-point hike and a higher end point in the RBNZ’s forecast tightening cycle.
The kiwi slipped 0.5% to 69.15 US cents, the lowest since early October. Two-year sovereign bond yields slumped 14 basis points to 1.96% while 10-year yields retreated as much as 11 basis points to 2.50%. The NZSE top-50 stock index rallied.
The RBNZ now expects to raise its benchmark rate to 2.5% by the third quarter of 2023, its new forecasts show. Previously, it projected the cash rate plateauing at around 2% from late 2023.
Speaking at a news conference after the decision, Governor Adrian Orr said the RBNZ would take a “cautious” approach to tightening by moving in 25 basis point steps “for now.”
One reason for that is households are carrying a large amount of debt that makes them sensitive to interest-rate changes, he said.
New Zealand’s job market is as tight as it’s ever been, with the unemployment rate of 3.4% matching a record low, while inflation at 4.9% is well above the RBNZ’s 1-3% target and forecast to accelerate further.
The bank now projects inflation running at 5.7% this quarter and next before it gradually eases back toward 2% over the next two years.
At the same time, there’s uncertainty around the economic outlook. Kiwis are bracing for Covid-19 to spread across the country when Auckland comes out of lockdown and a border around the city lifts next month.
“There’s a lot of inflation pressure out there and the need for tighter policy is self-evident,” said Sharon Zollner, chief New Zealand economist at ANZ Bank in Auckland. “But there is also an underlying fragility due to both debt loadings and our reluctant transition to living with Covid in our communities.”
The central bank estimates the economy contracted 7% in the third quarter from the second due to Auckland’s lockdown and restrictions elsewhere. It expects growth to bounce back in the current quarter but said household spending and business investment “will be dampened in the near-term” by ongoing health uncertainties.