RBNZ hikes 25bps but signals enough done.

The New Zealand dollar (NZD/USD) experienced a significant drop yesterday, falling by nearly 1.5%, in response to the Reserve Bank of New Zealand's (RBNZ) decision to raise interest rates by 25 basis points (bps). The accompanying communication from the RBNZ was more dovish than anticipated, leading to the sharp decline. The market had fully priced in a 25bps increase and had partially factored in a 50bps increase, resulting in a substantial 30bps decrease in the 2-year yield following the decision. The RBNZ expressed confidence that consumer price inflation would return to its target range, emphasizing that interest rates would remain at restrictive levels for some time. The RBNZ also released updated forecasts, indicating that the policy rate had reached its peak and that rate cuts would commence in the third quarter of 2024. Although the RBNZ raised its GDP projections, it still projected a mild recession with contraction in the second and third quarters.

Recently, market pricing had shown stronger conviction in expecting an interest rate hike, influenced by the government budget announcement on May 18th. The budget included additional spending, partly aimed at addressing the damage caused by a cyclone. Furthermore, it introduced measures to alleviate the cost-of-living crisis for households, likely influenced by the upcoming general election in less than five months. The budget resulted in a delay in achieving a budget surplus, now projected for 2026, and significantly revised upward the net immigration projections, which would contribute to GDP growth. The government forecasted 80,000 more immigrants than previously anticipated and revised away three-quarters of the projected GDP contraction.

Despite the fiscal policy changes implemented by the government, the RBNZ now places considerable faith in the lagged effects of monetary policy, expecting them to slow down the economy. In fact, some policy members argued for a pause, resulting in a 5-2 vote in favour of the rate hike, marking the first time a consensus was not reached.

In my opinion, this decision by the RBNZ is sensible. Despite relatively high inflation of 6.7% in Q1, the explicit guidance from the RBNZ has surprised the markets. However, considering that the RBNZ has been the most aggressive central bank among the G10 countries, with a total increase of 525bps, it has allowed itself the opportunity to pause. The tightening of global central banks will eventually impact the economy, leading to challenging global growth and disinflationary pressures later in the year. As recessionary conditions emerge in New Zealand and global growth remains subdued, the NZD is expected to underperform within the G10 currencies. Nevertheless, the level of interest rates will act as a limiting factor for downside potential. I anticipate that NZD/USD will rise as the US Federal Reserve pauses its tightening cycle and the US economy weakens, although the weakening economic conditions in New Zealand will moderate those gains.

This content may have been written by a third party. ACY makes no representation or warranty and assumes no liability as to the accuracy or completeness of the information provided, nor any loss arising from any investment based on a recommendation, forecast or other information supplied by any third-party. This content is information only, and does not constitute financial, investment or other advice on which you can rely.