The Reserve Bank of New Zealand Delivers Record Hike, Expects More Tightening

Record Rate Hike

The Reserve Bank of New Zealand delivered a historically big 75 basis points hike today, which brought the Official Cash Rate (OCR) at 4.25% and the highest level since the start of 2009 ^[1]. This acceleration is in contrast with other central banks that have already moderated the pace of tightening, or expect to do so.

The RBNZ is at the forefront of monetary tightening, as it runs its most aggressive cycle since 1999, when the OCR was introduced. It has delivered 400 basis points worth of rate hikes, in nine consecutive meetings, since the October 2021 lift-off.

Today's move was largely in line with market expectations and recent commentary by policy makers. In last month's Annual Report, governor Orr had highlighted the lagging nature of the bank's actions, stressing that "there is more work to do". ^[2]

More Tightening Ahead

Policy makers not only delivered a jumbo hike today, but also pointed to more tightening ahead, in order to bring inflation down. They noted that the official cash rate (OCR) "needs to reach a higher level, and sooner than previously indicated".

They now forecast the OCR to peak at 5.5% in 2023 and 2024, much higher than the 4.1% terminal rate projected back in August. They also expect rates to remain elevated for a long time and not fall below 5% before 2025.

The economy has been quite resilient and this has allowed the RBNZ to pursue this hawkish and aggressive tightening strategy, but this is expected to take its toll.

Impending Recession

The economy of New Zealand has avoided a recession so far, with a healthy 1.7% growth in the second quarter of the year (q/q), although there had been some warning signs.

The RBNZ's aggressive tightening along with other factors will eventually weigh on economic activity. The central bank alluded to that fact, since it now expects to enter a recession next year, partly as "a result of higher interest rates". ^[3]

In particular, GDP is projected to contract as much as 0.5% in mid-2023 and to return in positive growth figures, only in the final quarter of 2024. During today's press conference, governor Orr talked of a "shallow period" of contraction. ^[4]

Inflation & Employment

The main driver behind this aggressive tightening cycle of the RBNZ, is persistently high inflation. Headline CPI may have eased marginally to 7.2% y/y in Q3, but remains close to the 32-year highs print of the previous quarter (7.3%).

Policy makers believe that inflation is still "too high" see further upwards pressure in consumer prices, with CPI projected to peak at 7.5% in the two upcoming quarters and return below 3% in the second half of 2024.

Key drivers are the robust labor market and high wages, with the central bank noting today that employment "is beyond its maximum sustainable level".

The Unemployment Rate remained at very low levels at 3.3% in the September quarter and close to record low levels seen in recent quarters. The Reserve Bank of New Zealand expects it to rise significantly over the coming years and go as high as 5.7% in 2025.

NZD Reaction

The Kiwi got a boost from today's outsized rate hike and guidance for more tightening ahead, a markets contemplate a potentially smaller increase by the US Fed, while the Reserve Bank of Australia has already slowed the pace of its hikes.

As such, NZD/USD remains supported today, while AUD/NZD drops to the lowest level since March. However, the upcoming recession projected by the central bank may make tightening harder.