25 May 2022

Reserve Bank increases official cash rate to six-year high of 2 percent

5:47 pm on 25 May 2022

The Reserve Bank has raised its benchmark interest rate by 50 basis points (half a percentage point) to 2 percent and signalled similar-sized hikes in the next couple of months as it ramps up the battle against strong inflation.

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The increase in line with expectations as the central bank battles to get inflation, currently at a 30-year high of 6.9 percent, under control.

The RBNZ has signalled that further rate rises through the rest of the year will be needed to get inflation back to its target of around 2 percent.

It follows a similar-sized increase last month as the RBNZ moved aggressively to counter surging inflation, which is at a 30-year high of nearly 7 percent.

The Monetary Policy Committee, which sets the cash rate, said the economy had underlying strength but was being assailed by strong headwinds in the form of higher fuel and food prices, slowing global growth and uncertainty.

"The committee agreed to continue to lift the OCR at pace to a level that will confidently bring consumer price inflation to within the target range," it said in a statement.

Forecasts issued with the statement signalled further 50bps (basis point) increases most likely in July and August with smaller rises in September and December, taking the OCR towards 3.5 percent by the end of the year, and 4 percent by 2024, before rate cuts would be possible.

"A larger and earlier increase in the OCR reduces the risk of inflation becoming persistent, while also providing more policy flexibility ahead in light of the highly uncertain global economic environment."

The local economy was holding up well with a strong labour market, sound household finances, government spending, and a strong export sector, the committee said.

"However, headwinds are strong. Heightened global economic uncertainty and higher inflation are dampening global and domestic consumer confidence."

The RBNZ forecast inflation to peak at 7 percent in the middle of the year, before gradually easing to 5.5 percent at the end of the year and not getting back to its target zone until the end of 2023, while economic growth was expected to be anaemic for the next couple of years.

The RBNZ has two overriding mandates from the government to keep inflation settled around 2 percent and ensure maximum sustainable employment.

Governor Adrian Orr said the biggest single constraint on the New Zealand economy was the tight labour market and the inability to find staff, rather than the pace of wage rises, while the government's latest budget had added some stimulus to demand through it spending but in the overall scheme of things it was "small beer" in the inflation picture.

The New Zealand dollar jumped more than half a cent to 65.00 against the US dollar on the aggressive OCR forecasts, while wholesale interest rates rose as much as 20 basis points.

'All guns blazing'

Economists were generally surprised at the hawkishness of the RBNZ statement and were quick to cement 50 basis point rate rises in July and August into their forecasts.

"Today was a relatively straightforward decision for the RBNZ, as expected, but what was less expected was the "all guns blazing" approach to future inflation risks," ANZ chief economist Sharon Zollner said.

"More nuanced policy choices lie ahead, as the OCR moves further into contractionary territory, and the implications of shooting the housing market in the back with a machine gun become more evident."

However, Orr said the RBNZ was expecting house prices to fall about 15 percent from the peak of November last year through to the start of 2023, but he was confident that retail banks had been carefully "stress testing" borrowers to see if they could cope with interest rates of 6 percent or higher.

Core Logic chief property economist Kelvin Davidson said higher mortgages were inevitable as a result of the RBNZ hike.

"The implications are clear - we're not yet at the end of this rising cycle for mortgage rates, and that will keep a degree of downwards pressure on property values, especially since about 50 percent of loans are currently fixed and are yet to face the true costs of higher rates. But that day of reckoning will happen within the next 12 months."

The full text of the monetary policy statement can be read here.

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