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RBNZ Observer Update: Expected to hike rates next week

RBNZ Observer Update: Expected to hike rates next week

New Zealand’s economy continues to pick up strongly, supported by post-earthquake reconstruction, elevated export prices and rising household spending
With demand booming and the economy already operating at capacity, the RBNZ should raise interest rates to keep inflation contained
We expect the RBNZ to be the first developed world central bank to lift rates in this cycle, raising the cash rate by 25 basis points to 2.75% next week

Interest rates should start to head towards neutral

New Zealand’s economy is at the beginning of a boom and interest rates should be increased from their current low levels to keep inflation contained. We expect the hiking phase to begin next week, with the RBNZ likely to raise rates by 25 basis points to 2.75%. This would make the RBNZ the first developed world central bank to lift rates in this cycle.

The three key drivers of growth remain in place, supporting strong growth in New Zealand.

First, post-earthquake construction continues to ramp up and is expected to support growth for a number of years. Second, New Zealand’s export prices remain at high levels, as strong demand from China provides a substantial boost. Third, household spending has picked up, supported by the run-up in housing prices over the past year or so and low interest rates. Despite a cooling in the housing market in recent months, the fundamental factors underpinning housing also remain in place, with strong migration inflows continuing against a backdrop of weak supply. Consumer confidence is at the highest level since 2007, suggesting spending will likely pick up further in coming months.

These factors are set to persist for some time and underpin further strong growth in an economy that is already operating at capacity. Business surveys imply annual GDP growth in excess of 4.0%, a rate that is well above the economy’s estimated potential growth rate of around 2.5%. Cost pressures are expected to build.

As a result, the RBNZ should start to normalise interest rate settings if it is to achieve its inflation goals. We expect the RBNZ to hike rates by 100 basis points through 2014 as it seeks to manage New Zealand’s boom.

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