A third consecutive 50 point rise taking the Official Cash Rate to 2.5% is universally expected. The focus will be on any clues the Reserve Bank gives on what it might do next

Think about it. We are sitting here confidently expecting the Reserve Bank (RBNZ) will hike the Official Cash Rate (OCR) by a massive 50 points for the THIRD interest rate review in a row - and we won't bat an eyelid when it does.

You can get used to anything I suppose. That's one thing the crazy last two and a half years has taught us.

So, for the record, it's virtually guaranteed that the RBNZ's Monetary Policy Committee (MPC) will raise the OCR to 2.5% on Wednesday, July 13.

Remember that the OCR was dropped to an emergency setting of 0.25% on March 16, 2020 as the pandemic gripped. It wasn't till October 6 of last year that the RBNZ started to hike the rates again (after a false start in August due to, er, the pandemic).

So, this means, come Wednesday, we will have seen our key official interest rate hiked by a mind-boggling 225 basis points in little more than nine months.

And more to come, by all accounts.

To give some historical perspective, the OCR was introduced on March 17, 1999. I suppose as you would with any new toy, the RBNZ 'played with it' a bit and did do three 50 basis point hikes at various stages between the introduction of the new tool and May 17, 2000.

But after that we didn't see a double-jump increase in the rate again till April of this year. And now we're going to have three such jumps in a row, with very short odds on a fourth to follow in August.

(Of course, the OCR has been DROPPED in much bigger chunks at various stages, including a couple of epic 150 basis point cuts in the wake of 2008's Global Financial Crisis. And the emergency cut in March 2020 was 75 points.) 

The real questions for Wednesday that we might get some clues on are: Will there be a fourth double-banger in a row at the next review in August? And just how high will the OCR go in this 'cycle'.

On the latter point the RBNZ in its last Monetary Policy Statement at the back end of May suggested the OCR could be pushing 4% by the middle of next year.

Economists doubt that will be necessary and there's a reasonable consensus forming that the OCR will likely max out at 3.5% either late this year or early next.

The 'markets' have tended to have a somewhat more excitable view, with wholesale interest rates at one point suggesting a 'terminal' OCR of over 4.5%. The important thing about this is that the banks have been hiking their mortgage rates in direct response to the rising wholesale interest rates (a key source of funding), rather than the upward moves in the OCR, which have been lagging what the wholesale rates have been doing.

However, said wholesale rates have in more recent days now been taking some chill pills and have retreated to more in line with what the RBNZ has suggested will happen to the OCR.

The last time I looked the wholesale interest rates were pretty much 'pricing in' 50 basis point rises in the OCR at the reviews on Wednesday and in the following one on August 17. But the current pricing now sees a peak of around 3.8% early next year.

The easing in wholesale rates has seen some downward tweaking of bank mortgage rates in the past week. 

Personally, I would caution that those out there hopefully picking this might now be the 'top' of the mortgage rate cycle are likely being a bit optimistic. I hope I'm wrong. But inflation will decide. And I don't think it's finished with us yet.

Much will hinge on what the RBNZ says on Wednesday and then in its next full Monetary Policy Statement in August.

Any backing away from the full-speed-ahead, let's kill inflation at all costs, talk of the most recent public pronouncements from the RBNZ and you would expect to see those wholesale interest rates ease more.

Which is why in a nutshell the central bank will go ahead with the 50 point rise in the coming week and will likely, for now, retain its 'hawkish' language. And, for now, the presumption must be that there will be another follow-up 50 point rise in August, which would take the OCR to 3%.

But the populace is getting pretty grumpy. Last month the long-running Westpac McDermott Miller Consumer Confidence Survey produced the lowest reading since the survey's inception in 1988. ANZ's long-running Business Outlook Survey saw business confidence at near record lows. And this week's latest NZIER Quarterly Survey of Business Opinion showed business confidence at its weakest levels since those mind-swimming days of March 2020.

These surveys, however, were bad news in two ways. They suggested a big downturn is coming for the economy, BUT they were suggesting that inflationary pressures are still really strong as well. Double trouble.

As at the March quarter, our annual inflation was running at 6.9%. The figures for the June quarter are due for release on July 18. Economists currently see the June quarter as being the peak, at around 7% - which is exactly what the RBNZ itself is picking for the annual rate to June. But regardless of whether this is the peak, there's growing questions around how long inflation will remain at elevated levels for, with a reasonable amount of scepticism that the RBNZ will be able to get it down below 3% by the end of next year, as it currently forecasts.

So, despite grumbling consumers and businesses, it's the inflation that the RBNZ will keep focusing on - for now at least. Kick the economy again, it's still breathing!

It does of course very much open us up to the prospect of the dreaded Stagflation, which I hardly need remind anybody would see us having a stagnating economy, but with prices still going up. The worst of all worlds. The currently still super strong labour market provides hope against such a scenario. How long it stays strong, with unemployment at just 3.2% as of the March quarter, will be absolutely crucial.

For now though, what will the RBNZ be saying and doing in its OCR review? Over to the economists:

ANZ chief economist Sharon Zollner says the RBNZ "is on a roll with its 50-pointers", and the data-flow since the May Monetary Policy Statement has not provided any compelling reason to diverge from that strategy.

"At some point, assuming things continue to evolve smoothly (quite a big assumption in these volatile and unpredictable times, to be fair) the RBNZ will feel comfortable transitioning to a slower pace of monetary policy tightening (ie 25bp hikes) as the balance between near-term growth risks and medium term inflation risks becomes more nuanced than it is currently.

"We are predicting that will occur at the October Monetary Policy Review, as we are picking the RBNZ will get traction on cooling both household spending and construction activity a little faster than they are currently assuming."

She says, however, that a slowdown in the pace of hiking does require there to be no more upside inflation surprises.

"...The RBNZ won’t be expecting to see inflation indicators retreat meaningfully yet – monetary policy typically operates with a 12-18 month lag in that regard. It’s likely that both the housing and the labour markets will need to take some heavy hits before the RBNZ will feel comfortable the job is done. In the absence of a miracle growth spurt on the supply side of the economy, waning demand will have to be a large part of the transmission towards getting inflation and the economy back on a stable and sustainable path.

"Overall, we expect the RBNZ to strike a similar tone to the May Monetary Policy Statement – ie overwhelmingly hawkish. There will be a time for nuance and balance, but with inflation yet to peak, cost indicators still skyhigh, and inflation expectations yet to turn downwards, this isn’t it," Zollner says.

Westpac's acting chief economist Michael Gordon said that for now, the RBNZ will need to carry through with the interest rate hikes it has signalled, "or risk undoing its good work so far on bringing inflation pressures under control".

"But at some point in the coming months it will be appropriate to signal that the end of the tightening cycle is near."

Gordon said looking further ahead, the evidence for a softening in economic activity "is more anecdotal than definitive at this stage".

"Certainly there needs to be some kind of slowdown in order to bring inflation pressures into line. But the lags involved with monetary policy – many borrowers are only just starting to feel the impact of the OCR hikes to date – mean that the risk of overdoing it is genuine."

Gordon expects a fourth 50 basis points hike at the August review, which would bring the OCR up to 3%.

"That’s getting much closer to the RBNZ’s projected peak of 3.9% (and our forecast of a 3.5% peak), and is more plausibly in the range of ‘tight’ monetary policy settings. At that point, we think the RBNZ could signal that it’s getting on top of the situation, and that further OCR hikes are likely but will be data-dependent."

BNZ's head of research Stephen Toplis said domestically, leading economic indicators "are looking plain ugly".

"At the top of the list is the record weakness in consumer confidence. This must surely portend future softness in consumer spending, which accounts for almost two thirds of GDP."

If the BNZ economists were "in charge", they would probably argue for the RBNZ to be taking a cautious approach given that rates are now around neutral (mortgage rates arguably well above), leading economic indicators are "increasingly worrying" and uncertainty continues to reign, Toplis said.

"This being so, 25 basis point licks would seem an apt response," he said.. 

"However, we would be gobsmacked if the Bank did anything other than 50 [basis points] this time around, especially when market pricing is so convinced of such a move, largely because the RBNZ intimated that would be the case.

"What will be of most interest to us will be any sign that the Reserve Bank might be contemplating softening its stance down the track. In some ways the Bank has been given a get out of gaol free card in that it won’t be required to print a forward interest rate track at this meeting. [These only appear in Monetary Policy Statements, with the next of these to be issued in August.]

"This will buy itself time before it feels pressure to clarify its medium-term intent."

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