MNI INTERVIEW: RBNZ At Neutral Midpoint By December

The Reserve Bank of New Zealand is likely to raise the Official Cash Rate from 2.5% to the 3% midpoint of its estimated neutral range by December and could continue tightening into the first half of 2027 as it removes monetary stimulus, supports the New Zealand dollar and returns inflation to target, former Assistant Governor John McDermott told MNI.

McDermott, now executive director at Motu Economic and Public Policy Research, expects the Monetary Policy Committee to deliver another 25-basis-point increase in September, followed by further hikes in October and December.

"They're now well within sight of most estimates of neutral, so another increase at the next meeting makes sense," he said, pointing to the Bank's 2.5-3.5% range of estimates. "The economy has regained some momentum and is gradually absorbing spare capacity. At the same time, higher oil prices reinforce the case for tightening."

Without further policy action, core inflation is likely to remain around 2.5%-2.8%, making it difficult for the RBNZ to return inflation sustainably to its 2% midpoint target, he argued.

The September Monetary Policy Statement will allow policymakers to reinforce that message, though the pace of tightening thereafter will depend on incoming data, particularly Q3 inflation.

JULY HIKE INEVITABLE

McDermott said last week's hike had become increasingly likely after the MPC began preparing markets earlier this year, although uncertainty over oil prices complicated the timing. "The Bank warned in February that it couldn't maintain that degree of stimulus indefinitely. The May meeting showed the committee moving closer to tightening, and by July the momentum in the economy justified acting," he said.

McDermott had predicted an initial hike at the May meeting. (See MNI INTERVIEW: Market Underpricing RBNZ Hike - Fmr Asst Gov)

While the economy still has spare capacity, it is diminishing as activity gradually strengthens, making it appropriate for the RBNZ to move policy back toward neutral, he added.

Market pricing now suggests investors expect policy to move towards the upper end of the neutral range by mid-2027, with some chance rates become modestly restrictive. "Core inflation is still running around 2.5-2.7%, which is in the upper half of the target band. In that environment, policy probably needs to be neutral or slightly restrictive. Once they moved in July, markets simply adjusted to the guidance the Bank had been providing."

COMMUNICATION EFFECTIVE

McDermott said last week's decision was difficult because of heightened uncertainty, which led several economists to expect the MPC would pause.

Three of New Zealand's five major banks had forecast no change in July, largely because falling oil prices reduced near-term inflation risks. (See MNI RBNZ WATCH: Financial Conditions Prompt OCR Hike To 2.5%)

McDermott added that the New Zealand dollar's prolonged depreciation also strengthened the case for tightening last week. "New Zealand is a small open economy, so monetary conditions reflect both interest rates and the exchange rate. The currency's weakness wasn't simply short-term noise — it had become persistent enough to influence price-setting behaviour." While the exchange rate should not dominate every policy decision, once depreciation begins feeding into inflation expectations it becomes an appropriate consideration for the central bank, he argued.

He said some forecasters had also focused heavily on the short-term oil story, which added to uncertainty. "But the Bank consistently emphasised the medium-term outlook. Given the circumstances, it communicated that message as well as it reasonably could." He welcomed the RBNZ's greater transparency, although he acknowledged markets would need time to adjust to the new framework.

McDermott said the biggest uncertainties facing the RBNZ are the outlook for global demand and oil prices. "At the same time, parts of the global economy continue to be supported by strong investment in artificial intelligence, and that could affect demand in the markets New Zealand exports to. Those are developments the Bank will need to monitor closely."