Inflation Target, The Protagonist For A Faster Rate Hike

#OPINIONLEADER##RBNZ#

 DEC 2, 2021

A fully priced in rate hike

The New Zealand’s central bank lifted its official cash rate (OCR) by 0.25% last Wednesday, making it the second hike this year. However, as the market has already priced in a 0.25% hike from the Reserve Bank of New Zealand (RBNZ), the decision did not come as a surprise. Hence, the New Zealand dollar weakened across the board as the market was hoping for a hawkish 0.50% hike but did not get it.

RBNZ expects more interest rate hikes

The rate hike from the RBNZ is justified from several aspects. First off, employment in New Zealand for the third quarter doubled from the second quarter while unemployment rate has declined to the lowest level in over a decade. With that, the central bank has concluded that employment has reached its maximum sustainable level.

At the same time, annual inflation in the country has risen to 4.9%, way above the RBNZ’s 1-3% target amid the ongoing supply chain bottlenecks and the rising global oil prices. Although the central bank considers the rise in oil prices to be temporary, the reluctance of the OPEC+ to increase oil production supply despite receiving pressures from several major countries may keep prices floating at a high level for a longer than expected period.

Lastly, the central bank’s committee members concluded that the current level of home prices in New Zealand are unsustainable. But with more hikes in interest rate, home prices will likely be more sustainable.

Digging deeper into the policy report

Back in July, the RBNZ put a complete halt to its bond buying programme, the Large Scale Asset Purchase (LSAP) programme. The next progress for this quantitative easing (QE) programme will be to unload the central bank’s bond holdings. With the improving functioning of the bond market, the stimulus provided by the bond holdings has started diminishing. Hence, the RBNZ is planning to wind down its bond holdings and will provide more details on its plan early next year.

Although the RBNZ’s rate hike this time round was not hawkish, it did indicate in its projection material that more hikes can be expected when they resume their monetary policy meeting next year. In fact, the central bank projects its OCR to hit 2.1% by the end of 2022, a level higher than the pre-pandemic level. Based on the projected inflation data, the series of projected rate hikes is necessary. Although inflation is expected to peak at 5.7% during the first quarter of 2022, the decline that follows is not steep enough for inflation to fall within the RBNZ’s 1-3% target. Thus, inflation may still be a lingering issue next year which may prompt the central bank to hike interest rate at a faster pace.

RBNZ eyeing on inflation target

A couple of days after the monetary policy meeting, RBNZ Assistant Governor Hawkesby shared in an interview that moving forward, inflation expectations will be the main condition in determining whether the central bank should be hiking its OCR at a faster rate. Recent data release showed that two-year inflation expectations have risen to a 10-year high of 2.96%. He also highlighted that New Zealand will soon be “living with COVID” as lockdown measures in New Zealand are expected to be lifted next month, which partly explains why the central bank is expecting more rate hikes in the future.