Monetary policy tightening may finally have peaked

Monetary policy tightening may finally have peaked

Lady waiting at train station, clock in the foreground

The Reserve Bank conducted their regular review of New Zealand’s official cash rate this week and rather than increase it by the widely expected 0.25% they took it up by 0.5%. The cash rate now sits at 5.25% which is only just below the 5.5% peak predicted by the Reserve Bank in November and reaffirmed in February.

Why did the RBNZ increase the rate by 0.5% and not 0.25%?

It pays to remember that the markets had been expecting a half percent increase up until the problems with Silicon Valley Bank in the United states. Anticipation of a reduced willingness of banks to lend bringing a slight slowing in world growth led to an expectation that easing inflationary pressures would mean the Reserve Bank wouldn't have to raise the cash rate 0.5%. However, there are a couple of other things which had gone into the Reserve Bank thinking.

The first is the slight extra boost to New Zealand economic activity expected to come from the recent flooding, along with the risk of an easing of fiscal policy in an election year.

The other factor is concern by the Reserve Bank that recent reductions in bank wholesale borrowing costs as a result of the banking sector ructions offshore would lead to a fresh round of mortgage rate reductions here. They explicitly stated in the commentary accompanying the 0.5% rate rise that they have increased the cash rate to prevent a round of mortgage rate decreases. They did not say they expected interest rates to go up apart from deposit rates.

Have mortgage rates finally peaked in New Zealand?

We can now be reasonably confident that fixed mortgage rates have reached their peaks in New Zealand because even after the recent increases in wholesale borrowing costs as a result of the cash rate increase, they are still below peaks reached about a month or so ago.

But that wouldn't matter if the markets expected the Reserve Bank would need to take the cash rate a lot higher than where it is, and that is where things get interesting. For a year and a half now the Reserve Bank has been explicitly noting that monetary conditions would need to tighten further in order to suppress inflationary pressures. For the first time in a long while this week they removed that statement.

Instead, they wrote this. “The extent of this moderation (in domestic demand and underlying inflation) will determine the direction of future monetary policy.”

In other words, from here on out their monetary policy decisions will be data-driven. If we get extra evidence of weakness in the economy and we see an acceleration in a recent decline in inflation expectations, then the Reserve Bank will be unlikely to increase the official cash rate again.

The next cash rate review happens on May 24 and it's a 50:50 call as to whether they undertake the final projected 0.25% increase in the cash rate or not. We shall simply have to wait and see.

For borrowers, the news in the short term is likely to be slightly frightening

The media are likely to highlight the higher than expected 0.5% cash rate increase rather than the Reserve Banks removal of the warning that further rate rises will be necessary and their explanation that the rate rise was aimed at preventing mortgage rate cuts rather than pushing mortgage rates higher.

But overall, we and the Reserve Bank can see that inflationary pressures are slowly coming off and in particular the labour market is becoming less tight. That is important because a key route by which higher inflation leads to higher wages which lead to higher inflation et cetera is a shortage of employees. The Reserve Bank needs the unemployment rate to go up and they'll be feeling increasingly comfortable that that is likely to happen especially with the assistance of a large jump in net migration inflows.

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