The Reserve Bank’s (RBNZ) monetary policy committee is expected to raise the official exchange rate (OCR) after its first meeting of the year on Wednesday.
Most bets are on this, increasing the rate by 25 points from 0.75% to 1%, but a 50 point increase is a possibility.
Inflation is well above the committee’s 1-3% target range, with the consumer price index rising 5.9% in the year to the December quarter.
Meanwhile, the labor market is tight, with the unemployment rate standing at 3.2% in the December quarter.
However, uncertainty remains, with the omicron variant of Covid-19 only just taking off in New Zealand. Concerns over this could prevent the RBNZ from making a splash with a 50 point increase.
However, further supply chain disruptions caused by the disease locally (in addition to internationally) could actually be inflationary.
The Monetary Policy Committee should also provide guidance on how it plans to reduce the size of its bond holdings.
The RBNZ purchased $54 billion of New Zealand government bonds between March 2020 and July 2021 under its Large Scale Asset Purchase Program (LSAP), designed to exert downward pressure on interest rates.
The question is whether the RBNZ will let the bonds disappear from its balance sheet as they mature, or will it actively sell the bonds back to the Treasury.
BNZ chief strategist Nick Smyth sees him doing the latter. To see this story for more details.
The RBNZ is also expected to keep its Funding Loan Program (FLP) in place.
The scheme, launched in response to the pandemic, sees him lending money to banks at OCR. This is another mechanism that the RBNZ has used to suppress interest rates.
Some RBNZ watchers have called on the central bank to abandon the program because it seems counterintuitive that it is adding liquidity to the financial system at a time when it is tightening monetary policy.
However, the RBNZ has previously said it plans to stick to its word and keep the program in place until December 2022.
To date, banks have accessed $7.73 billion in term funding through the program. The last time a direct debit was taken was January 26.
Coming back to OCR, this will be the main focus of Wednesday’s monetary policy statement.
Observers will be interested to see how high the committee predicts the rate. Economists at the bank see it peaking at around 2.75% or 3% by the middle of next year.
Zollner sums up the arguments for a 25 point increase versus 50 point increase
As for the decision to go for the 25 or 50 point hike, ANZ chief economist Sharon Zollner expects the committee to opt for a 25 point increase. She provided a good summary of both schools of thought:
Argument for a 25 point increase:
– But you said. The RBNZ has made it clear that it prefers to move in regular 25 basis point increments unless the risks are a landslide in one direction.
– Less risky alternatives. Beyond moving the OCR itself, the forecast trajectory has a huge impact. A more aggressive OCR forecast offers greater initial tightening, with less risk of a reversal of current policy.
– Omicron’s mayhem has only just begun. It may be relatively short-lived, but it’s going to be intense and extremely stressful for many businesses, and a double up may seem a bit muted in this context.
– Broader financial conditions have tightened significantly. CCCFA and LVR rules have tightened the availability of credit. Swap rates suggest that mortgage rates will rise. Long yields are up. Our financial conditions index tightened rapidly.
– The housing market is already in decline, with home sales falling and annual house price inflation waning rapidly. This is very unusual this early in a trail cycle, when more generally the RBNZ is struggling to get traction. It’s quite a game changer.
Argument for a 50 point increase:
– CPI inflation in Q4 comes out at 5.9% (RBNZ expectation: 5.7%), driven by domestic inflation. The baseline measurements are all outside the target range.
– The Nike argument. If you’re sure you have a lot of work to do, why not get started? A slower start means higher rates for longer, all else being equal.
– The Bank of England almost launched its hike cycle with 50 basis points. It was a close thing, with a 5-4 vote. The Fed’s Bullard also favors a 50bp start in the US.
– The RBNZ has shown that it does not hesitate to surprise the market. And the market is on the fence anyway.
– Omicron is going to be inflationary, if anything. Experience from the rest of the world means that the RBNZ will be comfortable predicting that negative demand impacts from Omicron will be felt fairly quickly.
– NZD is down sharply. This will add to imported inflationary pressures.
– Energy prices continue to rise. Oil prices have an outsized impact on household inflation expectations in particular, but are also weighing on business costs.
“Foot in each camp” factors
– Inflation expectations in the RBNZ survey rose, with the 5-year measure increasing from 2.17% to 2.30%. A 0.3% deviation from the target midpoint is not insignificant on this time horizon, but it would be an overstatement to suggest that it is in the danger zone.
– Unemployment rate, at 3.2%, was in line with RBNZ expectations but with slightly disappointing employment and wage growth. Yet unemployment is at a new all-time high.
Sean Keane of Triple T Consulting also made an interesting point in a note he wrote for Credit Suisse.
“If the monetary policy committee were to hike 50 basis points, they should strike the right tone so that 3-5 year mortgage rates don’t start falling in expectation of the RBNZ containing inflation more quickly and triggers a faster downturn,” Keane said.
“That would mean raising 50 basis points and having a hawkish tone. The rates market should price the terminal rate above 3% in this scenario.
“Recent history suggests that the Committee’s preference is for a slow and steady tightening of monetary conditions, with the message remaining to let every meeting know that more rate hikes will be needed in the months ahead.
“The level of pricing pressure in New Zealand at the moment probably warrants a 50 basis point rate hike, but providing one raises curve control issues that the RBNZ may prefer to avoid at this stage. .”
Keane also said: “The RBNZ really should have increased the OCR by 0.50% at the last meeting of 2021, and by not doing so they allowed inflation expectations to strengthen further and faster. .
“Inflation is fast becoming a political as well as an economic issue in New Zealand, with the opposition National Party now pledging to scrap the RBNZ mandate on jobs and focus on housing. This means inflation outcomes will become increasingly important to the RBNZ and Prime Minister Ardern.