OCR reaction: higher interest rates expected

While the central bank kept the official cash rate on hold at 0.25% this week, it reduced its monetary support, ending its LSAP quantitative easing programme from July 23. Markets had expected the central bank to taper down the programme.

The RBNZ also removed wording around needing "considerable time and patience" to meet its targets. 

The Reserve Bank pointed to a brighter economic outlook, but cautioned the recent Covid restrictions in Wellington underlined the risks facing New Zealand. 

In its statement, the RBNZ said it expected a "near term" spike in CPI inflation, reflecting "one off" or "temporary" factors.

It expressed doubts, however, over the "pace and magnitude" of any pass-through of costs onto medium term inflation.

The central bank concluded that monetary support should now be reduced to "minimise the risk of not meeting its mandate".

Economists believe the RBNZ has begun to lay the groundwork for rate increases next month.

ANZ predicted an OCR increase in August in wake of the comments, "with CPI and labour market data to provide the final evidence the RBNZ requires".

ASB's Nick Tuffley said the central bank was "preparing for lifting the OCR". He also moved forward his prediction of an OCR hike to August.

"It’s a fine line but we now expect the RBNZ will lift the OCR in August – provided key data between now and then are sufficiently strong to support the need for earlier removal of stimulus."

Jarrod Kerr of Kiwibank said today's comments offered "a sneak peek into the bank’s bias for policy direction".

"The next move is almost certainly a rate hike ... But the timing is likely to be much earlier than the RBNZ signalled just six weeks ago."

Kerr was slightly more cautious on the outlook for rate increases: "Today’s message is consistent with a central bank juggling near term inflation pressures and long term deflationary forces. A rate hike in November is a definite maybe. Although November still feels too early to us."

Kiwibank noted that wholesale markets edged 4-5 basis points higher following the Reserve Bank announcement – with markets giving a greater likelihood to higher interest rates this year.

Kerr predicts the wholesale market movements will begin to have an impact on shorter term mortgage rates.

Kiwibank said two year swap rates, which banks use to hedge two year fixed mortgages, had moved 37 basis points higher over the past few weeks. The bank added it was "only a matter of time before all rates, especially the one-to-two year rates are re-priced higher, to reflect the move in underlying wholesale rate".