Mark Lister, 18 February 2022

The Reserve Bank of New Zealand (RBNZ) will announce its first interest rate decision of 2022 soon. It will pick up where it left off last year, with another rise in the Official Cash Rate (OCR) virtually guaranteed.

We are likely to see another increase of 0.25 per cent, which will take the OCR to 1.00 per cent. That’s still low by historic standards, but it would be the highest since 2019 and well above the rock bottom levels at the height of the pandemic.

There has been some speculation we might see the RBNZ move more aggressively and hike rates by 0.50 per cent, or fifty basis points.

There’s an outside chance of that, but it’s unlikely. While outsized cuts in the OCR have been common during times of crisis, we’ve only seen two instances of a 0.50 per cent hike. Those came in 1999 and 2000.

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The change in the OCR itself will only be part of the story, and financial markets will be more focused on what happens to the banks forecasts for what might happen over the rest of the year.

The RBNZ makes an interest rate decision every six weeks, and at every second one of those it also releases a Monetary Policy Statement (MPS).

This one is an MPS, which means a plethora of supporting material rather than just a brief statement. This will include a fresh set of projections about where the RBNZ sees growth, inflation and the OCR going over the coming few years.

After confirming the change to the OCR on the day, economists will very quickly head straight for RBNZ’s latest forecasts for the balance of this year and into 2023. They’ll be looking to see how it has changed compared to the last MPS, which was released in November last year.

Back then, the RBNZ was expecting unemployment to fall to 3.2 per cent by the end of 2021, which is exactly what happened. It saw that as the low point in the cycle and expected unemployment to drift higher thereafter. In contrast, the labour market has remained exceptionally tight, and many bank economists now see unemployment going lower still.

The inflation picture has also changed, with cost pressures proving even more acute than the RBNZ expected. It saw the annual inflation rate rising to 5.7 per cent in the December 2021 quarter, remaining at that level for the following quarter before falling back to 2.9 per cent a year later.

Inflation rose to 5.9 per cent in the December quarter, and it feels like the peak is still to come, making those RBNZ estimates look a little light.

If the central bank does revise its unemployment forecasts lower and its inflation estimates higher, one would think it will also outline a stronger path for the OCR, compared to where it was before. This is where the rubber hits the road for financial markets, and borrowers for that matter.

The November MPS suggested an OCR about two per cent by the end of this year, rising to about 2.50 per cent a year after that.

Financial markets, which have the luxury of responding immediately to all available information, all the time, have already moved to expect something higher. At present, they imply an OCR of either 2.50 or 2.75 per cent at the end of this year.

That’s two or three more hikes than the RBNZ had in their previous numbers, and roughly what is expected in terms of an increase from the prior forecast.

Nothing is clear cut, and there are numerous risks to the outlook. Then again, we have seen a marked change in attitude from other central banks in recent months, and the RBNZ is no longer out on a limb as the only one looking to withdraw monetary support.

This, along with growing inflationary risks, should ensure another OCR increase within the week, and more to come over the balance of the year.