RBNZ Preview: We expect a hike, but pace of further tightening increasingly uncertain

The Reserve Bank of New Zealand announces monetary policy this Wednesday, and we expect it to deliver a 25 basis point rate hike. That appeared to be a well-telegraphed move also at the August meeting, but the announcement of a nationwide lockdown in New Zealand days before the RBNZ announcement convinced policymakers to keep rates unchanged instead.

Recent communication by the RBNZ, in particular via the comments of Assistant Governor Christian Hawkesby, conveyed two main points: a) the hike was simply postponed, and should be delivered in October; and b) the RBNZ should not opt for an aggressive 50bp increase for now.

The second point muted some speculation about a more aggressive hike – which had been fuelled by previous comments by Hawkesby – and now appears to be further endorsed by the inability of New Zealand to fully eradicate the new Covid-19 variant, and parts of the country (in particular, Auckland) still stuck in a lockdown.

Markets are pricing in an 80% probability of a rate hike this week, signalling how there is still some marginal speculation that the RBNZ will postpone its first hike again. In our view, there is too much evidence that the New Zealand economy is running hot – as shown in the table below – to keep rates at record lows.

Inflation is above the 1-3% inflation target, and a very tight labour market suggests higher prices may be more persistent than in other developed economies. Incidentally, house prices have continued to rise despite the government’s measures aimed at curbing speculative real estate investment. Data by CoreLogic show that housing inflation in New Zealand reached a new peak (27.8% year-on-year) in September. On this topic, we could see the RBNZ announce further tightening of the loan-to-value ratio (LVR) restrictions on mortgages, but we doubt this will be enough to deflate the NZ housing bubble unless the Bank starts raising the policy rate.

New Zealand’s “zero cases” approach during the pandemic surely allowed the country’s economy to stand out as an outperformer. Now, as Auckland enters yet another week of lockdown, many are starting to question whether the Government will be able to fully eradicate the new Covid strain, and opposition parties have started to suggest an easing of restrictions and the acceptance of a low-contagion rather than a zero-contagion status-quo.

The ability of the government to successfully move back to zero cases in the community or their decision to shift to less draconian restrictions clearly hold the keys for the economic outlook in New Zealand in the coming months. From a monetary policy perspective, this – and the economic damage already done by restrictions in August and September – has increased the uncertainty around the pace and timing of RBNZ tightening.

As shown in the chart below, current pricing implied in the OIS market shows markets are currently close to the RBNZ rate path published in August. Any signals that the RBNZ is turning less upbeat on the economic outlook may well prompt some shift lower in the curve, and ultimately weigh on NZD.

However, given the uncertainty on how long restrictions will remain in place in New Zealand and the lack of evidence around the economic impact of the recent lockdowns, we think RBNZ members will have little interest in radically changing their view on the economy just yet. We think they will leave the discussion about the timing of further hikes very open ended as they deliver the first hike this week.