MNI INTERVIEW: RBNZ Will Need 4% OCR By Mid 2027 - Ex Advisor

The Reserve Bank of New Zealand is likely to need to lift the Official Cash Rate from its current 2.5% to around 4% by the middle of next year to return core inflation to the 2% midpoint of its target range, former senior adviser Leo Krippner told MNI, adding that the Bank's estimate of the neutral rate is too low.

Krippner, now a research fellow at Singapore Management University, said the RBNZ's assumption that the OCR would peak at around 3.3% underestimated the amount of tightening required, reiterating his argument from 2025 that the neutral rate is closer to 3.75%-4.0%. (See MNI INTERVIEW: RBNZ's Neutral Estimate Too Low - Ex-Economist)

"The OCR needs to move above neutral to put sufficient downward pressure on core inflation," he said, noting that underlying price pressures remain stubborn, with core inflation still running around 2.5% in Q2, despite the 4.1% headline inflation read broadly in line with the Bank's May forecast.  

"The Bank clearly recognises it still has work to do, but its projected peak in the OCR looks curious given inflation remains above target," Krippner argued.

Financial markets currently expect the OCR to reach around 3.5% by May 2027, but Krippner argued even that may prove insufficient. Without moving policy into restrictive territory, the Bank would instead have to rely on spare capacity, including a negative output gap and elevated unemployment, to complete the disinflation process.

FINAL HALF-PERCENT

Krippner said that central banks consistently underestimate how difficult it is to reduce inflation from around 2.5% to their 2% targets. "It's just whether or not they want to make the effort of getting the last half percent down to 2%. At the moment, their forecasts do have it going down to 2% but that's almost automatic. If you're not going above neutral, then how much downward pressure are you actually putting on inflation to wring that last half a percentage point out?"

He said core inflation does not typically fall by itself. "You have to do the work if you're serious about returning inflation to target," he added, warning a failure to eliminate the remaining inflationary pressure could ultimately lift long-term price expectations and bond yields. 

"At the moment, I don't think central banks should be anticipating that inflation will naturally come down," he continued. "If markets conclude central banks are content with inflation settling around 2.5% rather than 2%, long-term interest rates will remain structurally higher." Higher government borrowing worldwide is already pushing up term premia, while persistent above-target inflation would add a further upward bias to longer-term rates, he said.

POLICY RESPONSE

Krippner said the RBNZ eased too aggressively when it cut the OCR to 2.25%, and that policy remained well below neutral settings despite core inflation staying above target.

He also questioned why policymakers waited until July to begin tightening after signalling in May that higher rates would be required. (See MNI RBNZ WATCH: Financial Conditions Prompt OCR Hike To 2.5%)

"If the Bank already knew more tightening was needed, it would have made more sense to begin earlier." Nevertheless, Krippner welcomed Governor Anna Breman's governance reforms, particularly greater transparency around individual votes and the restoration of eight policy meetings a year.