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RBNZ Observer Update: On hold as still spooked by high NZD

RBNZ Observer Update: On hold as still spooked by the high NZD

The RBNZ left the cash rate unchanged at 2.50% today. The central bank was noticeably more upbeat on the outlook for domestic activity. However, their concern over the high NZD seems to have held them back from hiking rates today. Instead, the RBNZ significantly bolstered their tightening bias, flagging that interest rate rises would be needed and noting that they expect 'to start this adjustment soon’. With demand booming and inflation already running ahead of the RBNZ’s expectations, we expect that they will need to hike rates soon in order to keep inflation contained. A hike seems likely in March.

Facts
• The RBNZ kept its overnight cash rate unchanged at 2.50% today (12 of 15 analysts expected no change; HSBC had expected a 25 basis point hike).
• On economic activity, the central bank was more upbeat, noting ‘New Zealand’s economic expansion has considerable momentum’.
• On the NZD, the RBNZ continued to note that ‘the Bank does not believe the current level of the exchange rate is sustainable in the long run’.
• On the outlook for policy, the central bank flagged ‘a need to return interest rates to more-normal levels’ and that the RBNZ ‘expects to start this adjustment soon’.

Implications
Momentum is continuing to build in the New Zealand economy, and the RBNZ acknowledged this in today’s statement, presenting a noticeably more upbeat view on the economy. With demand booming and the economy already at capacity, cost pressures are beginning to rise and the central bank strengthened their tightening bias by flagging upside risks to the inflation outlook.

However, despite increased inflation risks, a stronger domestic outlook and recent upside surprises to the RBNZ’s own forecasts the central bank chose not to lift rates today. In our view, a strong case could be made for tightening rates now. However, lingering concerns about the high NZD seem to have been a key factor behind the central bank’s decision to delay increasing rates – with the central bank continuing to note that, in their view, the current level of the exchange rate is not sustainable in the long-run.

Instead, the RBNZ flagged that rate increases are imminent, strengthening their language around the need for higher interest rates. The RBNZ noted that the current economic environment suggests ‘a need to return interest rates to more-normal levels’ and that they ‘expect to start this adjustment soon’. A hike seems likely in March.

Bottom line
The RBNZ left the official cash rate unchanged at 2.50% today and strengthened their language around the need for higher interest rates.

The central bank presented a more upbeat view on the outlook for the domestic economy, but lingering concerns about the high NZD seem to have driven a further delay in tightening.

With demand booming and the economy already operating at capacity, a hike in March seems likely in order to keep inflation contained.

ENDS

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