New Zealand Will End QE in Possible Prelude to Rate Hike

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New Zealand’s central bank said it will reduce monetary stimulus by ceasing quantitative easing, a surprise move that sent the currency higher as traders priced in an interest-rate increase as early as August.

The Reserve Bank’s Monetary Policy Committee, led by Governor Adrian Orr, on Wednesday held the official cash rate at 0.25%, but said it will halt bond buying under its Large Scale Asset Purchase program by July 23. The statement omitted a previous reference to the need for considerable time and patience to achieve its inflation and employment goals.

“Members agreed that the major downside risks of deflation and high unemployment have receded,” the RBNZ said. “The committee agreed that a ‘least regrets’ policy now implied that the significant level of monetary support in place since mid-2020 could be reduced sooner.”

New Zealand is in the vanguard of developed-world central banks that are beginning to normalize policy. Canada is expected to keep scaling back stimulus later today and South Korea will provide guidance on its plans at Thursday’s meeting. Signs are emerging that New Zealand’s economy may be overheating, pushing inflation toward the top of the RBNZ’s target range.

Investors are now fully pricing in a rate hike in November, up from an 82% chance before the statement, and there’s now a 76% probability of a move in August. New Zealand’s dollar rose to 70.16 U.S. cents at 3:30 p.m. in Wellington, from 69.64 cents before the release. Two-year swap rates jumped to 0.96%, the highest since February 2020.

“The RBNZ has clearly changed tack,” said Nick Tuffley, chief economist at ASB Bank in Auckland. “The risk of inflation and employment undershooting their objectives has switched to the risk of overshooting should the current level of stimulus remain in place.”

He now expects the RBNZ to start raising rates in August rather than November. ANZ Bank also changed its call and is forecasting an August increase.

A majority of economists surveyed by Bloomberg last week didn’t expect a hike until the second quarter of 2022. In May, the RBNZ projected it would start raising rates in the second half of 2022.

Important Tool

The RBNZ said today that while LSAP purchases “were no longer necessary for monetary policy purposes” the program “remains an important tool for supporting the efficient functioning of the New Zealand debt market if required, and remains an important monetary policy tool if needed.”

New Zealand’s success in eliminating the coronavirus from the community has given its economic recovery a head-start, putting the RBNZ at the forefront of stimulus withdrawal.

While some other central banks are also signaling an end to ultra-loose policies by tapering bond purchases, the RBNZ has gone a step further with an abrupt halt -- although it had reduced weekly purchases to NZ$200 million ($140 million) from as much as NZ$1.8 billion in early 2020.

The Reserve Bank of Australia last week announced a pared-back extension of its bond buying, while saying it doesn’t expect to lift borrowing costs until 2024. In Asia, only the Bank of Korea has said that rate increases are in the pipeline this year.

The RBNZ said today that economic conditions since late 2020 have been consistently stronger than anticipated.

“More persistent consumer price inflation pressure is expected to build over time due to rising domestic capacity pressures and growing labor shortages,” the committee said in its Record of Meeting. Still, “uncertainties remain as to the pace and magnitude of any pass-through of costs onto medium term inflation,” it said.

The RBNZ’s willingness to remove stimulus earlier comes despite global uncertainty as more infectious variants of Covid-19 spread, and while risks to the domestic economic outlook remain. The border is expected to stay largely closed to the outside world until 2022, and a slow vaccination roll-out has left the nation vulnerable should Covid-19 breach its defenses.

Still, New Zealand’s economy is growing faster than expected and the housing market is booming. A business opinion survey last week signaled that growth will be sustained and be accompanied by increased inflation pressure and more demand for workers.

A report Friday is expected to show annual inflation lifted to 2.7% in the year ended June, nearing the top of the RBNZ’s 1-3% target range. The jobless rate fell to 4.7% in the first quarter and economists expect it to drop toward 4% in 2022.

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