New Zealand Raises Rates to Tame Inflation With More to Come

(Bloomberg) -- New Zealand’s central bank raised interest rates for the first time in seven years and signaled further increases will likely be needed to tame inflation.

The Reserve Bank’s Monetary Policy Committee, led by Governor Adrian Orr, lifted the official cash rate by a quarter percentage point to 0.5% Wednesday in Wellington, as expected by most economists. Policy makers said they see the economy recovering quickly once a lockdown in largest city Auckland is eased.

“The current Covid-19 restrictions have not materially changed the medium-term outlook for inflation and employment” and “capacity pressures remain evident,” the RBNZ said. “The committee noted that further removal of monetary policy stimulus is expected over time.” 

The move puts New Zealand at the forefront of the exit from ultra-loose policies employed by central banks during the pandemic, with only the Bank of Korea and Norway’s Norges Bank among peers to have already raised rates.

The RBNZ’s planned tightening cycle could be interrupted by the persistent delta-strain outbreak in Auckland, which is hurting business confidence and damping the growth outlook.

“Risks around growth are to the downside, but inflation risks are to the upside. That’s awkward,” said Sharon Zollner, chief New Zealand economist at ANZ Bank in Auckland. 

While another rate increase in November looks firmly odds on, “risks are skewed toward something coming along to derail the RBNZ’s hiking cycle before its completion,” she said.

The New Zealand dollar initially rose on the decision before retreating to trade lower. It bought 69.32 U.S. cents at 3:50 p.m. in Wellington, down from 69.55 cents beforehand. The NZSE top-50 stock index slipped into the red.

The RBNZ delivered the hike at an interim rate review rather than with a quarterly Monetary Policy Statement, meaning it won’t publish new forecasts or hold a press conference. 

False Start

The central bank was poised to raise rates in August but held off because New Zealand entered a nationwide lockdown on the day of that decision. Most of the country has since exited lockdown, but the outbreak continues to fester in Auckland, prompting the government to extend restrictions there, and has spread to the neighboring Waikato district.

The RBNZ initiated its last tightening cycle in March 2014, delivering four hikes in quick succession, but needed to unwind them a year later when the inflation it was expecting failed to materialize.

This time around, inflation is already in breach of the bank’s 1-3% target band, having accelerated to 3.3% in the second quarter.

The RBNZ said it expects inflation to increase above 4% in the near term before returning toward the 2% midpoint of its band over the medium term. 

What Bloomberg Economics Says

“In our view, a sluggish pace of global policy normalization will restrain the RBNZ’s ability to raise rates at a fast pace. We see a recovery in labor supply easing skills shortages as borders partially reopen, containing wage rises and muting underlying inflation pressure.”

-- James McIntyre, economist

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Prior to the latest coronavirus outbreak, New Zealand’s economy was booming. Gross domestic product surged 2.8% in the second quarter, unemployment dropped to 4% and house prices have surged 31% over the past year.

The RBNZ said it is aware that the latest Covid restrictions have badly affected some businesses in Auckland and a range of service industries more broadly, and that there will be longer-term implications for economic activity from the pandemic. 

However, the higher vaccination rates rise, “the less virus-related disruption there will be to New Zealand’s economic activity over coming years.,” it said.

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