NZD & The RBNZ- almost at peak tightening?

New Zealand has led the way for major economies with their policy tightening cycle. Overnight, the Reserve Bank of New Zealand (RBNZ) hiked by another 0.5%, as expected. There are potentially signs that the central bank is nearing the end of the road however.

The New Zealand Dollar (NZDUSD) has fallen over the past few days and is now retesting the 20 day moving average from above. Will the recent uptrend persist or are the bears still in command?

The question for the RBNZ is just how much further will they go? After hiking the base interest rate to 3%, RBNZ Governor Orr spoke with reporters, saying:

“Our view is that sitting around that 4% official cash rate level buys the monetary policy committee right now significant comfort that we would have done enough to see inflation back to our remit”

Which suggests two more 50bps hikes and they’d be done. That’s a strikingly confident posture given the current economic trends. As the RBNZ note in the MPS economic snapshots:

Annual CPI inflation has continued to increase, reaching 7.3 percent in the June 2022 quarter, due to a mixture of domestic and international factors.

Measures of persistent or ‘core’ inflation have also increased. Expectations for inflation have eased recently but remain elevated relative to history.

Indeed, this also prompted the RBNZ to increase their projections of the Overnight Cash Rate (OCR) slightly vs the May decision:

And the justification for the rate hike should be familiar to central bank watchers:

Conditional upon our central economic outlook and assumptions, the OCR is projected to increase by more than was assumed at the time of the May Statement (figure 2.22). The higher outlook for interest rates reflects stronger inflationary pressures (global and domestic) than had been previously assumed.

These pressures more than offset the weaker outlooks for the housing sector and global growth. Higher interest rates will ensure that demand slows sufficiently for the MPC to meet its employment and inflation objectives.

The central bank admits that they’re contending with “household budgets have been bolstered by high levels of employment, savings built up during COVID-19 lockdowns, and government support payments.”

But perhaps more importantly, the higher than expected wage inflation will be a huge headwind for the RBNZ’s quest to return inflation to the 2% target.

If consumers achieve pay rises, this negates or weakens the impact of rate increases on households, allowing them to keep up with inflation and continue spending.

There’s a big difference between the May and August projections for wages/labour costs:

Which raises the prospect that the neutral rate (the rate at which interest rates are neither stimulating nor slowing the economy) could be higher than anticipated. This was mentioned as a risk at this policy meeting:

“the Committee discussed the possibility that neutral interest rates may be higher. For example, market-based estimates of neutral nominal interest rates have increased over the past year. Staff will be undertaking further work to review their estimates.”

If this is the case, Governor Orr’s assertion that with a 4% rate “we would have done enough to see inflation back to our remit” could be in for a serious test…