New Zealand Dollar Jumps as RBNZ Comes Out Swinging

RBNZ Governor Orr

Image © Pound Sterling Live, Still Courtesy of RBNZ

The New Zealand Dollar rallied after the Reserve Bank of New Zealand raised interest rates by a further 50 basis points and indicated it was set to do so again at the next two meetings.

The Monetary Policy Committee (MPC) increased the Official Cash Rate (OCR) to 2.0 percent and said "monetary conditions need to act as a constraint on demand".

This statement alone suggests the RBNZ is willing to cull economic growth if required to bring inflation down.

"The RBNZ is worried about continuing to overshoot its objectives, and has come out swinging," says Mike Jones, Senior Economist at ASB in Auckland. "We thought the RBNZ would come out swinging, but today’s Statement was even more hawkish than we and financial markets were expecting."

The RBNZ policy action and guidance were supportive of the New Zealand Dollar outlook and the currency is the best performing major of the day:

NZD is the best performer

Above: NZD performance on May 25.

Heading into the RBNZ meeting the market was heavily 'short' against the Kiwi amidst deteriorating sentiment towards the New Zealand economy, this market positioning therefore raised the prospect of a relief rally as shorts were squeezed out and profits on existing trades were booked.

The Pound to New Zealand Dollar exchange rate is lower by two thirds of a percent at 1.9275, the New Zealand to U.S. Dollar exchange rate is up 0.85% at 0.6501. (Set your FX rate alert here).

The RBNZ looks intent to stick to its stated policy of acting aggressively early on in the cycle to get on top of inflation expectations before they become more self sustaining.

"A larger and earlier increase in the OCR reduces the risk of inflation becoming persistent, while also providing more policy flexibility ahead in light of the highly uncertain global economic environment," said the RBNZ in a statement.

The RBNZ noted that although the global economy is facing increased headwinds the New Zealand economy remains robust and employment remains above its maximum sustainable level, with labour shortages now the major constraint on production.

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The Committee said it would continue to lift the OCR at pace to a level that will confidently bring consumer price inflation to within the target range.

"Two consecutive 50bps rate hikes have been delivered, and we now expect a further two in July and August reflecting the Bank’s renewed urgency to get the OCR onto the tighter side of neutral," says Jones.

ASB raise their terminal OCR - the rate at which the RBNZ completes the cycle - to 3.25%, and bring forward expectations for the first rate cut of the next easing cycle to February 2024.

"To remove any doubt about whether the Bank is trying to guide market pricing to do its tightening work for it, the Statement was littered with fighting talk," says Jones.

In particular he singles out the MPC's desire to be "resolute" in its commitment to "confidently" bring elevated consumer price inflation down to within the target range.

"This is the talk of a central bank worried about the updrift in inflation expectations and keen to stamp its authority all over the task at hand," says Jones.

He suggests the only way the RBNZ can achieve this is to squash demand. "The Bank’s intention to (aggressively) use the OCR to bring aggregate supply and demand into alignment couldn’t be clearer."

OCR projections

Above: RBNZ OCR projections. Source: RBNZ

The RBNZ's new guidance shows the OCR at 3.25-3.50% by year-end (up from 2.25-2.50% in the February projections) and around 200bp of total tightening by the end of 2023.

This suggests a terminal rate around 4.0%.

But some analysts are wary of the RBNZ's ability to deliver on such hikes.

"We start to suspect that the RBNZ might have gone too far on the hawkish side with its rate projections and could struggle to deliver on them," says Francesco Pesole, FX Strategist at ING, "especially if we see a considerable cooling-off in the New Zealand housing market and a generalised global slowdown."

Pesole says such questions are however a story for the long run.

"In the short term, we have a near-guarantee that the RBNZ will deliver two more half-point hikes this summer, which should keep rate expectations anchored to the new RBNZ projections and allow NZD to maintain a wide rate differential against all other G10 currencies," he adds.