Article written by Alex Cousley, Russell Investments – 5th October 2021

The Reserve Bank of New Zealand (RBNZ) raised the Official Cash Rate today to 0.50% (previously 0.25%) – and have hinted that another rate rise is likely soon. This rate rise had been flagged and was anticipated by the market. Even with future rate rises, monetary policy will still be an accommodative stance for some time. RBNZ Assistant Governor Hawkesby recently confirmed this in a speech titled ‘A least regrets approach to uncertainty’, highlighting that we are going to see a gradual withdrawal of monetary stimulus – rather than an aggressive normalisation.

On the announcement, government bond yields rose slightly (10 year yield at 2.048%), the equity market pared back some of the morning’s gains and the currency is virtually unchanged as of publication.

There is currently a dichotomy within central banks between those willing to look through transitory inflation (for example, the US Federal Reserve, ECB and RBA) and those that are a bit more anxious and want to begin on the path of normalisation earlier (Norges Bank, Bank of England, Bank of Canada). It has been clear for a while that the RBNZ were in the latter camp, and today’s action cements that. Similar to the comments made by Hawkesby above, this dichotomy does mean that the RBNZ will not be able to pursue an aggressive tightening path without putting undue stress on the exchange rate.

In terms of why the RBNZ have decided to raise interest rates, the New Zealand economy has more than fully recovered from the COVID -induced downturn. Nominal GDP is now running above pre-pandemic levels and the unemployment rate back to 4% in the second quarter of 2021 – which is in line with where it was at the end of 2019. Along with this, inflation is running above the target.

Looking ahead, we still see some uncertainty in the near-term outlook for the New Zealand economy related to COVID. The New Zealand government have been very successful in containing outbreaks through aggressive restrictions in mobility – and it is possible that the economy experiences another lockdown. On the positive side though, the vaccination rate continues to rise, and the re-opening of the borders will provide a boost to the economy – especially the tourism-exposed sectors.

Current market pricing is quite aggressive, with 3 additional rate rises expected by August 2022. Given the uncertainties mentioned above, and our expectation that major central banks are going to be slow at beginning to raise interest rates – we think these expectations may have to be reduced, and the RBNZ’s comments today certainly reaffirm Assistant Governor Hawkesby’s focus on a gradual path forward.