The Reserve Bank of New Zealand Raised Rates, but Signaled the End of its Hike Cycle

Another Rate Increase

The Reserve Bank of New Zealand had raised rates by another outsized 0.5% in its previous meeting in April, against market expectations for a smaller move, but the uncharacteristically vague guidance had created some uncertainty around the rate path. ^[1]

Today, policymakers opted for a smaller 25 basis points increase that brought the official cash rate to 5.5% and the highest since 2008. The decision itself definitely did not constitute a surprise, even though two members dissented in favor of a pause (out of seven). ^[2]

The End of Hikes

This time around, the bombshell came not from the size of the move, but from the bank's projections around the appropriate policy path. The Monetary Policy Statement reveals that the current OCR of 5.5% is expected to be the terminal rate, while rate cuts are likely to follow from second half of the next year, since the official cash rate is projected to fall to 5.3% by the end of 2024. ^[3]

This marks a watershed for the Reserve Bank of New Zealand, which has been at the forefront of monetary tightening and highlights the uncertainty around central banks, which appear to be all over the place. The RBNZ was the first major central bank to increase rates all the way back in October 2023, having delivered twelve consecutive hikes worth 525 basis points, in its most aggressive cycle since 1999 when the OCR was introduced.

Easing Inflation

Policymakers adopted this aggressive tightening approach in order to bring down surging inflation, which had risen up to 7.3% y/y in Q2 2022 and the highest level in three decades. Since then, CPI has shown some moderation, printing 6.7% y/y in the first quarter of 2023 – the smallest increase in over a year.

The policy committee believes that inflation has peaked and that it will continue to decline moving forward, as the level of interest rates is "constraining spending and inflation pressure". It also expressed confidence that inflation will return to the 1-3% target, by maintaining rates at restrictive level for some time. ^[2]

Overly Optimistic?

Despite this confidence, policy makers don't expect the Consumer Price Index to fall back within the 1-3% range before the back-half of 2024. More to it, the labour market is still very tight, with unemployment close to its historic lows and elevated wages. The Labor Cost Index (LCI) rose 4.3% y/y in Q1, which is the biggest increase since the data started in 1992. ^[4]

The above data make one wonder whether the RBNZ is overly optimistic that it will be able to tame inflation, without having to raise interest rates past their current level.

NZD/USD Reaction

The RBNZ pointed to the end of its aggressive rate hike cycle, since officials view the current rate as the peak, against market expectations for more tightening. This sparked a sharp decline of NZD/USD.