Fundamental Updates: The Cautious Kiwi (25 November 2021)

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 NOV 25, 2021

As widely expected, we see a further tightening of monetary policy from the Reserve Bank of New Zealand (RBNZ) during the meeting on Wednesday. But the decision did not gain any positive market reaction for the New Zealand dollar as the 0.25% hike in interest rate had already been priced in. It was a 0.50% hike that the market was yearning for. Once the market did not receive the 0.50% hike, a strong sell-off in the New Zealand dollar followed across the board.

Catalysts for more rate hikes: maximum employment, high inflation and rising home prices

The RBNZ highlighted that employment in New Zealand is now above its maximum sustainable level while unemployment rate has declined to the lowest level in over a decade. At the same time, annual inflation in the country has risen to 4.9%, way above the central bank’s 1-3% target amid the ongoing supply chain bottlenecks and the rising global oil prices. Furthermore, the RBNZ is expecting prices to remain high in the near term before declining back down to within their targeted range.

On the matter of home prices, the central bank’s officials concluded that the current level of home prices are unsustainable but noted that continued hikes in interest rate will likely lead to more sustainable home prices.

Bond holdings under LSAP no longer significant

With the functioning of the bond market improving, the RBNZ has stopped purchasing bonds under the Large Scale Asset Purchase (LSAP) programme in July. Furthermore, the current holdings of the bonds purchased by the central bank are only providing meagre stimulus. Thus, the RBNZ will be providing more details on winding down its bond holdings early next year.

All is not lost!

Although the modest rate hike was kind of a disappointment, causing the New Zealand dollar to take a hit, it is likely that the impact will be temporary. The RBNZ’s interest rate projection for 2022 indicates that rate hikes are expected in every quarter of the year, with interest rate rising to 2.1% by year-end. This interest rate level has surpassed the pre-pandemic level, thus indicating the central bank’s forecast that the New Zealand economy in 2022 is likely going to outperform the year just before the pandemic struck.

The projection material also showed that the RBNZ is expecting annual inflation to peak at 5.7% during the first quarter of 2022 before declining steadily to 3.3% by year-end. However, the expected decline throughout the year is insufficient for inflation to fall within the central bank’s 1-3% target. And so, the officials may still consider a more aggressive rate hike as an option in the future in order to add more downward pressure on prices.