Mark Lister, 15 February 2023

This coming Wednesday will be a big day for financial markets, with the Reserve Bank of New Zealand (RBNZ) set to announce its first interest rate decision of the year.

We last heard from the RBNZ in November, when it increased the Official Cash Rate (OCR) by a super-sized 0.75 per cent, the highest in history.

That took the OCR to 4.25 per cent, the highest since January 2009. It also meant the Bank had increased its policy rate by a whopping 4.00 per cent in just 14 months, which is the most aggressive tightening cycle we've ever seen.

They'll continue on that path this week, with another OCR hike all but assured.

It probably won't be as big as last time, with the RBNZ expected to return to the half a per cent moves which prevailed for most of 2022.

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That would take it to 4.75 per cent, nowhere near the pre-GFC high of 8.25 per cent many will recall from 2008, but much higher than anything the current generation of borrowers have experienced.

More importantly, we’ll be very interested in the RBNZ’s updated economic and financial projections.

There are seven OCR decisions a year, but on four of these occasions we also get a Monetary Policy Statement (MPS).

These always give great insights into where the RBNZ expects inflation, interest rates and the economy will go from here.

Back in November, the new projections got as much attention as the jumbo rate hike.

The RBNZ said it saw the annual inflation rate peaking at 7.5 per cent, and unemployment falling to a fresh low of 3.2 per cent, which in turn would necessitate the OCR going up to 5.5 per cent.

It also made the rare move of explicitly forecasting a recession (albeit a relatively shallow one), with four consecutive quarters of negative growth pencilled in from June 2023.

While this sounds ominous, don’t forget that the RBNZ wanted to see a moderation in economic activity, consumer behaviour and wage expectations.

In addition to raising interest rates, frightening us all into fears of recession was another effective way of achieving this.

To some extent, it’s worked.

In the three months since, price pressures have softened, the labour market has eased, and confidence has fallen sharply.

In the December quarter, non-tradables inflation (which reflects the domestic price pressures the RBNZ has been worried about) rose just 1.5 per cent. That's still too high, but it was well below RBNZ forecasts for a 1.9 per cent increase.

While the labour market still looks tight, there are signs things are beginning to soften there too.

The unemployment rate increased slightly to 3.4 per cent at the end of 2022. That's still very low, but it's the highest in 18 months and was above RBNZ forecasts for 3.2 per cent.

Wage growth also slowed, pointing to an improving balance between supply and demand.

The strong comments and gloomy forecasts weren’t lost on consumers or businesses either.

The Westpac McDermott Miller measure of consumer confidence fell to an all-time low in December (based on data going back to 1988), while business confidence saw a similarly dramatic drop.

in December, the own activity measure of the ANZ Business Outlook survey slumped to its weakest since June 2020, falling even lower than it was during 2008 and 2009.

The current backdrop is nowhere near as dire as it was back then, but the extremely cautious comments from the November MPS clearly had an impact.

With things moving in the direction, the RBNZ can probably afford to bring a slightly more relaxed perspective to Wednesday’s meeting.

However, I doubt it will. It won’t want to squander these recent gains, just as it’s having some success.

Expect another chunky hike in the OCR, and more tough talk about there still being “more work to do.”

Even if the RBNZ is quietly content with the direction of travel, it won’t want us to know that just yet.