Rate Hike Deferred, Not Deterred.

#OPINIONLEADER# #JacksonHoleEconomicSymposium#

 AUG 26, 2021

Being the first central bank to put an end to quantitative easing (QE), the Reserve Bank of New Zealand (RBNZ) was all set for a hike in its official cash rate during their August meeting. However, things took a turn when New Zealand Prime Minister Jacinda Ardern announced last Tuesday that the country is entering a nationwide level 4 lockdown with immediate effect.

Last minute change of plan.

Just 24 hours before the widely expected rate hike announcement from the RBNZ, the first community COVID-19 case since February was reported in Auckland last Tuesday. Few hours later, Prime Minister Arden carried out her “go hard, go early” strategy on tackling COVID-19, putting New Zealand into a nationwide level 4 lockdown.

This led to the holding of rates unchanged at 0.25% by the central bank. In the rate statement, the RBNZ highlighted that the “decision was made in the context of the Government’s imposition of Level 4 COVID restrictions on activity across New Zealand”, indicating that a rate hike was initially planned to take place during the August meeting.

The hawkish hold.

Taken aback by the RBNZ’s action, the market started selling off the New Zealand dollar, leading to its weakness across the board. Although the central bank decided to put its rate hike on hold, this is by no means a dovish tone sent out by the RBNZ.

Looking at the latest release of the quarterly projections, the central bank is forecasting annual inflation in the next two quarters to be way above its 2-3% target range before settling down within that range in 2022. Perhaps the most hawkish part of this meeting is the RBNZ’s forecast for interest rate hikes. During the previous projection material release, the central bank was expecting a rate hike only in the third quarter of 2022 (which was deemed by the market to be very hawkish as compared to its other counterparts). Adding on to the hawkishness, the central bank is now expecting a rate hike in the fourth quarter of this year. Furthermore, it is also expecting a rate hike during every quarter of 2022.

Governor Orr determined to hike rate during next meeting.

Two days after the RBNZ’s monetary policy meeting, the central bank’s Governor Adrian Orr said in an interview that COVID cases by itself will not stop the central bank from raising interest rates. Instead, it will require “a significant shock to demand” for the RBNZ to change its mind. Governor Orr also mentioned that the central bank should focus on their inflation and employment goals and not on lockdowns that happen from time to time.

With the robust economic recovery in New Zealand, it is not surprising that the central bank is inclined towards policy tightening. In fact, the economy has been making strong progress towards the central bank’s goals with recent data indicating that inflation has risen to 10-year high; employment rose at the fastest pace in 2.5 years; and unemployment rate has fallen back to the pre-pandemic level. Furthermore, Prime Minister Ardern’s tough border policy in containing the COVID virus has led to a shortage of labour as migrant workers are unable to enter the country. As a result, there was a surge in demand, leading to the economy running hot. Adding fuel to fire, property prices in New Zealand have risen 31% as of end-July. Hence, a hike in interest rate will push up borrowing costs and potentially avoiding a housing bubble.

RBNZ likely to deliver a rate hike.

To conclude, it is likely that the RBNZ will be carrying out a rate hike during the next meeting on 6 October given that the New Zealand economy is already overheating. From now till then, Prime Minister Ardern has 1.5 months to contain the COVID outbreak and lift the lockdown measures. Of course, nothing is guaranteed. But in order for the central bank to push back further on its rate hike, this will require a longer period of nationwide lockdown that strongly impacts demand, which is unlikely going to happen given Prime Minister Ardern’s tested and proven “go hard, go early” strategy on COVID containment.