What might OCR hikes mean for markets?

The Reserve Bank meets later this month, and there’s an outside chance the Official Cash Rate (OCR) will rise by 0.25 per cent.

If there’s no move this month, the focus will shift to the July meeting, where markets see an 0.25 per cent move as almost certain.

That would be the first hike in three years, and it would have come much earlier than anyone expected before the Iran conflict started.

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After the OCR was reduced from its 15-year high of 5.50 per cent to 2.25 per cent, the next move was always going to be up.

The only area of debate was when, with most economists picking late this year or early in 2027.

That would’ve been an OCR increase to celebrate, if there is such a thing.

I say celebrate because it would’ve likely happened for the right reasons, namely an economic recovery on the back of falling unemployment, rising business profitability and higher activity.

Interest rate rises that come against that sort of backdrop are usually taken in stride by investors and borrowers alike.

However, a move this month or in July would be quite different.

It will be in reaction to worries that high fuel prices will feed into stronger inflation everywhere else.

While it’s debatable whether that’ll happen, businesses are telling us they intend to raise their prices and households are saying they expect that too.

This means behaviour is likely already starting to change, which could force the hand of the Reserve Bank.

What‘s missing here is the stronger economy we’d usually have when talking about the first OCR hike of a tightening cycle.

We’d barely lifted ourselves out of recession when the conflict started, so those green shoots haven’t had time to mature.

That means we’ll face higher interest rates at a time when activity is stagnant, the labour market is stuck in neutral and house prices are slipping again.

All of that causes consumers to put spending plans on ice, crimping demand for businesses at the precise time they’re seeing their costs increase.

That’s bad for confidence, margins and profitability, which tends to be reflected in many local share prices.

Since the OCR came into being in 1999, I count 209 monetary policy decisions.

Most of those resulted in no change, about six or seven out of ten.

There have been 75 adjustments, evenly split between 35 cuts and 40 hikes.

The biggest cuts have been 1.50 per cent, we saw two of those in 2008 and 2009 as the GFC took hold.

The largest hike was a 0.75 per cent move, which came in 2022 as the Reserve Bank found itself playing catchup to sharply rising inflation.

That’ll be fresh in its memory and it won’t want to repeat that mistake, which is why it would rather move early and gradually, rather than needing to do more later.

Unsurprisingly, when we look back at how the local sharemarket has responded to OCR moves, it does better in the wake of cuts rather than hikes.

In the 12 months following an OCR cut, NZ shares have increased 13.3 per cent, on average, and been higher 93 per cent of the time.

After a hike, that average return falls to 5.1 per cent and the market has been higher a year later just 65 per cent of the time.

The hikes from the 2021 to 2023 era of very high inflation are a big part of those weaker statistics.

In contrast, the sharemarket performed strongly when the OCR started rising in 2002, 2004, 2010 and 2014, especially earlier on in the hiking cycle.

Through those periods, the market averaged a 15.5 per cent return in the 12 months following an OCR hike, and it was up 100 per cent of the time.

That’s because interest rates were rising for the right reasons, in response to a growing economy and buoyant conditions.

That wasn’t the case after the pandemic, when the highest price pressures in three decades were the main reason for Reserve Bank action, and it won’t be this year either.

Businesses, households and investors are likely to face a more challenging period as policymakers try and nip this inflation spike in the bud before it gets out of hand.

That’ll be uncomfortable in the short-term, but hopefully it’ll limit how far they need to push interest rates up overall.

The Reserve Bank didn’t move quickly enough in 2021 and 2022, and it ended up hiking the OCR from 0.25 to 5.50 per cent in a short space of time.

That was the most aggressive hiking cycle we’d ever seen, and the one-year mortgage rate tripled in just two-and-a-half years.

If the OCR moves from 2.25 per cent up to 3.00 per cent relatively quickly, that’ll avoid bigger moves down the track.

The local sharemarket might be a sideways performer while this runs its course, and investors might again find international markets a more lucrative hunting ground.

Another silver lining could come in the form of lower risk investment opportunities, as bonds and fixed income begin to offer more attractive levels of income.

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