Monetary Tightening Begins in New Zealand

March 12, 2014

Governor Wheeler announced a hike in New Zealand’s Official Cash Rate (OCR) from 2.5% to 2.75%.  Thus begins the second effort since the Great Recession by the Reserve Bank of New Zealand to nomalize interest rates.  The first attempt raised the rate twice by 25 basis points in June and July of 2010 but was aborted in March 2011 after the severe South Island earthquake.  Such prompted a 50-basis point reduction back to the cyclical low of 2.5%, where the OCR had stayed for the last three years. 

In mid-2008, the OCR had been at 8.25%, but in seven moves between July and April 2009, it was slashed to 2.5%.

Wheeler indicated that today’s action is the first of several increases:  “the speed and extent to which the OCR will be raised will depend on economic data and our continuing assessment of emerging inflationary pressures.”  If growth proceeds at the pace monetary officials now expect, on-year CPI inflation is projected to accelerate slowly from 1.6% last quarter to 1.9% by the third quarter of this year and 2.1% by 4Q15.  The inflation target midpoint happens to be 2.0%, so it is important to start raising interest rates now so as to contain expected inflation, preserve the credibility of monetary policy and to lift interest rates “towards a level at which they are no longer adding to demand.” 

On-year growth, which is becoming more broadly based and getting fed in part by net immigration, is presently around 3.3%.  That is also the central bank’s projected 4Q14 over 4Q13 growth rate.  Over the ensuing year, however, the objective is to slow growth to a pace of about 2.2%.  A complicating factor is the elevated level of the New Zealand dollar (NZD), which although holding down inflation in the tradable goods sector remains an economic “headwind.”  A critical assumption is that “the Bank does not believe the current level of the exchange rate is sustainable in the long run.”  If that proves not the case, the OCR is unlikely to rise as quickly as Wheeler suggests.  It is imagined that the 90-day bill rate will climb about 250 basis points over the next three years, but it is also assumed that the trade-weighted kiwi, as the NZD is known, is currently peaking and likely to depreciate 4% over the same 3-year span of time.

With no other advanced economy, including neighboring Australia, even close to the time of raising interest rates, the view that the kiwi is cresting seems more like wishful thinking than a well-reasoned argument.

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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