RBNZ leaves monetary policy settings unchanged, but reintroduces forward interest rate forecasts suggesting a first Official Cash Rate rise in the second-half of 2022; Kiwi dollar jumps

The Reserve Bank has left the key monetary policy settings unchanged and says the current visible price pressures in the economy will abate over the course of the year. 

But it has reintroduced forward forecasts for the Official Cash Rate (OCR) in its latest Monetary Policy Statement. And these suggest the central bank expects to start raising the OCR in the second-half of 2022.

It sees the OCR hitting 1.5% by the end of 2023 and then 1.75% by the middle of 2024.

The New Zealand dollar immediately reacted by jumping over three-quarters of a cent against the American currency to go above US73c. Wholesale interest rates also took off. Westpac head of NZ strategy Imre Speizer said two-year swap rates rose from 0.52% to 0.59%, 10-year swap rates rose from 1.89% to 1.96%, and the 2031 NZ Government Bond yield rose from 1.76% to 1.86%.

For now though, the OCR stays at 0.25% (where it has been since March 2020) and the Large Scale Asset Purchases (quantitative easing) programme remains with a limit of $100 billion of bonds to be purchased by June next year.

Capital Economics, the first of the major economic forecasters to predict rate rises next year said, if anything, the RBNZ is "more hawkish than we are" as it believes rates may need to be lifted to around 1.5% by end-2023 instead of the 1.0% level  they have currently pencilled in.

"With the RBNZ set to become one of the first central banks in advanced economies to hike rates, we think that the New Zealand dollar will continue to strengthen against the US dollar," Capital's senior Japan, Australia and New Zealand economist Marcel Thieliant said.

ASB economists say they were a little surprised to see the RBNZ "be so forthcoming", with the publishing of a OCR track signalling rate hikes, an acknowledgement that the OCR cannot remain at emergency levels forever.

"While we share the RBNZ’s view that the OCR will move up in 2022, their pace of hikes over the next few years is larger than what we envisage," ASB economist Nat Keall said.

Westpac acting chief economist Michael Gordon says the RBNZ "appears to have been moved not by stories of rising inflation, as the market might have expected, but by concerns that the labour market is much tighter than it previously thought".

"It is forecasting a sustained lift in wage pressures, and is less prepared to accept an overshoot on its employment mandate.

"We’re less sure about such a sustained lift in wage growth, though we acknowledge that it’s an unusual environment. The closure of the international borders in response to Covid-19 has closed off the flow of both skilled and unskilled migrant workers that employers would normally have expected. But it’s not clear that this will spur higher wage growth at a national level, and its persistence will depend on when and how migration flows resume."

These are the latest forecasts from the Monetary Policy Statement:

This is the latest statement from the the RBNZ:

The Monetary Policy Committee agreed to maintain the current stimulatory level of monetary settings in order to meet its consumer price inflation and employment objectives. The Committee will keep the Official Cash Rate (OCR) at 0.25 percent, and the Large Scale Asset Purchase and Funding for Lending programmes unchanged.

The global economic outlook has continued to improve, with ongoing fiscal and monetary stimulus underpinning the recovery. New Zealand’s commodity export prices have benefited from this rise in global demand. However, divergences in economic activity, both within and between countries, remain significant. The sustainability of the global economic recovery remains dependent on the containment of COVID-19.

The near-term economic data will continue to be highly variable. While economic growth in New Zealand slowed over the summer months following an earlier strong rebound, construction activity remains robust. The aggregate level of employment has also proved resilient, while fiscal spending continues to support domestic economic activity.

However, tourism-related business activity continues to be affected by the absence of international visitors, with the recent opening of Trans-Tasman travel expected to only partially offset revenue losses. The extent of the dampening effect of the Government’s new housing policies on house price growth and hence economic activity will also take time to be observed.

Overall, our medium-term outlook for growth remains similar to the scenario presented in the February Statement. Confidence in the outlook is rising as the more extreme negative health scenarios wane given the vaccination progress globally. We remain cautious however, given ongoing virus-related restrictions in activity, the sectoral unevenness of economic recovery, and the weak level of business investment.

A range of international and domestic factors are currently resulting in rising costs for businesses and consumers. These factors include disruptions to global raw material supplies, higher oil prices, and pressure on shipping arrangements. These price pressures are likely to be temporary and are expected to abate over the course of the year.

The Committee noted that medium-term inflation and employment would likely remain below its Remit targets in the absence of prolonged monetary stimulus. The Committee also noted that while the low interest rate environment has supported house prices, other factors such as recent tax changes, the growing supply of housing, and lending restrictions, are providing offsetting pressures.

The Committee agreed to maintain its current stimulatory monetary settings until it is confident that consumer price inflation will be sustained near the 2 percent per annum target midpoint, and that employment is at its maximum sustainable level. Meeting these requirements will necessitate considerable time and patience.

Summary Record of Meeting

The Monetary Policy Committee discussed economic developments since the February Statement, and their implications on the outlook for inflation and employment. The Committee noted the ongoing improvement in global economic activity and the associated rise in long-term wholesale interest rates. Fiscal and monetary stimulus are continuing to underpin the global recovery. However, the varied pace of national vaccination programmes, and the re-introduction of COVID-19 containment measures in some countries, means that the growth outlook remains uncertain, and uneven within and across countries.

Economic activity in New Zealand has returned to close to its pre-COVID-19 level. The increase in economic activity has been supported by ongoing favourable domestic health outcomes. This has led to a catch up in consumer spending, supported by substantial monetary and fiscal stimulus.  Improving global demand and higher prices for New Zealand’s goods exports are also contributing to economic activity.

The Committee discussed the key factors underpinning the economic recovery and agreed that the outlook was unfolding broadly as outlined in the February Statement. The improvement in global and domestic economic indicators, such as New Zealand’s terms of trade, have provided members more confidence in this outlook. However, the Committee agreed on the need for caution as domestic activity remains uneven across sectors of the economy.

The Committee noted areas of the economy where business activity levels remained low. The sectors most exposed to international tourism remain weak, despite the recent re-opening of travel with Australia. Business investment also remains below its pre-COVID-19 level, although recent indicators of investment intentions suggest signs of recovery.

The Committee noted that the level of employment has remained resilient. Reports of specific skill and seasonal worker shortages have the potential to put upward pressure on some wage costs. The economy is experiencing pockets of both labour shortages and employment slack, consistent with the economic disruption caused by COVID-19.

The Committee agreed that, in aggregate, the current level of employment remains below their estimates of the maximum sustainable level but expect it to converge to that level over time. They also expect to see wage growth lift as firms compete for labour, in particular given the current low levels of immigration.

The Committee noted that underlying CPI inflation currently remains slightly below their target midpoint of 2 percent per annum. A range of domestic and international factors are expected to lift headline inflation above 2 percent for a period. Members noted these factors are expected to be temporary and include higher international transport costs, disruptions to global raw material supplies and resulting higher prices for many commodities, and administrative charges.

The Committee discussed the risk that these one-off upward price pressures may promote a rise in more general inflation and inflation expectations. However, the Committee agreed that these risks to medium-term inflation were mitigated by ongoing global spare capacity and well-anchored inflation expectations.

The Committee assessed the effect of its monetary policy decisions on the Government’s objective to support more sustainable house prices, as required by its Remit. It was noted that the current level of house prices result from a range of factors including low global and domestic interest rates, housing supply shortages, land use regulations, and strong investor demand.

However, the Committee acknowledged that some of the factors supporting house price growth have eased. In particular they noted the current high rate of housing construction, historically low population growth, increased loan-to-value ratio restrictions, and the Government’s recent changes to housing tax and supply policies. These factors place downward pressure on the longer-run level of sustainable house prices and are consistent with a period of significantly lower house price growth.

The Committee noted risks remain to economic growth both on the upside and downside. However, they expressed greater confidence in their outlook for the economy given the reduced risk of extreme downside shocks to the economy from COVID-19.

The Committee noted that on current projections the OCR eventually increases over the medium term, but agreed that this is conditional on the economic outlook evolving broadly as anticipated. In line with their least regrets framework, members reinforced their preference to maintain the current level of monetary stimulus until they were confident that the inflation and employment objectives would be met. They agreed this would require considerable time and patience.

The Committee discussed the effectiveness of monetary policy settings since the February Statement. The Committee noted staff advice that the LSAP programme has provided substantial monetary policy stimulus to date.

Staff noted that reduced government bond issuance was placing less upward pressure on New Zealand government bond yields. This also provided less scope for LSAP purchases with the limits outlined in the letter of indemnity, specified as a percentage of government bonds outstanding. Based on current Treasury projections for the issuance of New Zealand government bonds, the Committee acknowledged that the LSAP programme could not reach the $100bn limit by June 2022.  Members affirmed that this dollar figure was a limit, not a target.

Members endorsed staff continuing to adjust weekly bond purchases as appropriate, in particular taking into account market functioning. The Committee agreed that weekly changes in the LSAP purchases do not represent a change in monetary policy stance, and that any desired change in stance would be made via the usual Monetary Policy Committee communication channel.

The Committee agreed that the OCR is the preferred tool to respond to future economic developments in either direction.

The Committee agreed to maintain its current stimulatory monetary settings until it is confident that consumer price inflation will be sustained near the 2 percent per annum target midpoint, and that employment is at its maximum sustainable level. The Committee agreed it will take time before these conditions are met.

On Wednesday 26 May, the Committee reached a consensus to:

• hold the OCR at 0.25 percent;
• maintain the existing LSAP programme; and
• maintain the existing Funding for Lending Programme (FLP) conditions.

The Monetary Policy Statement is here.