MNI RBNZ WATCH: Financial Conditions Prompt OCR Hike To 2.5%

The Reserve Bank of New Zealand raised the Official Cash Rate by 25 basis points to 2.5% in a unanimous decision despite an improved inflation outlook on Wednesday, and Governor Anna Breman said that leaving rates unchanged would have allowed financial conditions to ease further.

Breman reiterated that further tightening is likely and said the Committee judged a rate increase was needed as growth had strengthened while inflationary pressures from the Iran conflict remain a risk.

"In addition to inflation falling, growth is looking considerably stronger. So we stress that we believe that this is a balanced approach by hiking 25bp to get and make sure that inflation does really fall while still supporting the economic recovery,” she said.

Breman said inflation remained well above the 1-3% target band, despite oil price declines prompting the Bank to lower its near-term forecasts. The Bank now expects annual inflation of 3.9% in Q2 and 3.3% in Q3, down from its previous expectation that inflation would peak at 4.3% later this year.

Wednesday's move, which markets had priced with about an 80% probability, was the Bank's first rate increase since May 2023. (See MNI RBNZ WATCH: Hikes Considered, But Not Certain) Overnight index swaps rose 4-9bp following the decision, with markets pricing the OCR at around 2.89% by December and with roughly a 70% probability of another increase at the September meeting.

Breman declined to provide guidance on timing of further tightening. "We have the potential now to see inflation falling and growth recovering at the same time, so we're not going to comment on any specific meetings. We still believe that it's likely we'll have to withdraw some more monetary stimulus, but the timing is highly uncertain."

FINANCIAL CONDITIONS

Falling wholesale interest rates, reflecting expectations of lower inflation, had widened the gap between swap and mortgage rates, reducing pressure on banks to lift lending rates, she said.

Assistant Governor Karen Silk said lower oil prices had reduced global policy rate expectations, pulling New Zealand wholesale rates lower alongside the removal of an earlier liquidity premium in swap markets. "We've seen quite a significant shift down in the wholesale interest rates, and so, as the governor's explained, that means that the gap between the swap rate and the mortgage rate has widened... that reduces the pressure on banks to increase mortgage rates."

Chief Economist Paul Conway added that a stronger U.S. dollar, driven by expectations for further Federal Reserve tightening, had also weakened the New Zealand dollar, contributing to easier domestic financial conditions.

LSAP UNWIND

Breman also announced the RBNZ would complete the unwind of its Large Scale Asset Purchase programme by June 2027, bringing forward the sale of its remaining bond holdings. "This is to improve operational efficiencies, and it has no material impact on the stance of monetary policy," Breman said.

The RBNZ began LSAP reductions in February 2022 through bond maturities and managed sales after launching the programme in March 2020 to provide additional monetary stimulus when the OCR was near its effective lower bound during the pandemic. 

The RBNZ ultimately purchased about NZD53.5 billion of government securities under the programme, below its NZD100 billion limit, before ending purchases in July 2021. Subsequent increases in interest rates reduced the market value of those holdings, resulting in substantial accounting losses.