We Are Recovering, No Doubt. But It’s Slow. Too Early For Hikes. Let The Patient Recover

• The RBNZ’s decision, updated forecasts, and OCR track, will dominate Kiwi headlines this week. The cash rate will be left at 2.25%. But that’s not in question. It’s the lift in forecasts, with good news, that will see a lift in the OCR track. How far will they go? Hopefully not too far in signalling a hike this year (which is too early)
• It’s important to note that we’ve seen a tightening in financial conditions since the RBNZ’s last decision in November. Wholesale rates have lifted, and mortgage rates have lifted. Do we need higher rates? No, not yet. Give it time. See more around the move in wholesale and retail rates in this week's special topic
• Our COTW takes a look at the ugly lift in inflation expectations. They’ve naturally followed the move higher in actual inflation over the past year. But with headline inflation set to cool over the coming months, expectations should follow suit, and we should see a lessening in inflation pressure.

Here’s our take on current events

New year, new governor, new guidance. So, what’s in store from the Reserve Bank in 2026? On Wednesday, we will get a refreshed read on how the RBNZ are assessing current economic conditions since their last meeting. And it has been a long wait since all the way back in November.

There is no question that the cash rate will remain on hold at 2.25% on Wednesday. So, it’s the overall tone, the updated forecasts, and the lift in the OCR track, that will be closely watched by all.

It’s clear the RBNZ will enjoy summarising the stronger data we’ve seen since November. There’s good news for a change. The lift in activity indicators and sentiment have many calling out “green shoots” again. Added to the good news, was some heat in prices. The stronger inflation print that ended last year, was linked to the ugly lift in inflation expectations (see our COTW for more). And taking all that into account, the RBNZ’s updated forecasts will show stronger growth and stickier inflation. That should translate into the OCR track being pushed up and pulled forward.

We expect the small chance of a further rate cut, which was embedded in November’s track, to be removed. The economy has shown enough signs of recovery to justify calling time on the easing cycle. And we agree with markets that the next move is up. But it’s the timing of that move that we disagree with (for now).

The RBNZ’s November track had implied the hiking cycle commencing in the second half of 2027. With stickier inflation and better growth, that’s likely to be brought forward. The key question is: by how much? We hope the RBNZ avoids getting ahead of itself. A refreshed track pointing to an early2027 liftoff feels appropriate to us. But market traders are much more aggressive, with almost two hikes priced this year. That’s too punchy, and premature.

Yes, we’ve had stronger than expected data. We like it. We’re recovering. But the economy is not yet taking off, and a year from fully recovering. But what does it mean for Governor Breman’s laser focus on inflation? Good, all central bankers should be. But being laserfocused on inflation means looking beyond the headline inflation print, understanding the underlying drivers, and looking at the inflation outlook. In our case, inflation may have lifted to 3.1% in the December quarter, but it’s not being driven by demand yet. And we still expect inflation to ease to 2% through 2026, without the need for rate hikes, supported by spare capacity in the economy. The looseness in the labour market and softness in the housing market being the big ones.

For the economic recovery, we’re just at the starting line. And it’s like doing the 400m hurdles with a broken leg in cast. It’s still a painful and awkward recovery. And it’s way too early to claim victory over the recovery. And as such settings should remain accommodative over 2026, to further support the recovery.

Chart of the Week: Ouch! The lift in inflation expectations hurts a little.

We’ve seen quite an ugly lift higher in the RBNZ’s Survey of Inflation Expectations. Across all time horizons, expectations of inflation have risen and moved further away from their September 2024 low’s when inflation expectations were anchored back at 2%.

The one-year ahead measure has climbed a whole 20bps higher to 2.59%. Meanwhile the two and five year ahead measures each lifted 9bps to 2.37% and 2.31% respectively. And painfully, the ten-year ahead measure lifted to a series high of 2.30%, surpassing the previous record of 2.28% seen in 2023.

Though unwelcome, the recent lift in inflation expectations does not come with much surprise. Indeed, inflation expectations have been edging their way higher over much of 2025 as headline inflation began lifting from its low of 2.2% to most recently 3.1% - a touch above the RBNZ’s target band.

The RBNZ may be feeling some discomfort around its credibility as an inflation fighter. Along with the risk that higher inflation expectations could become embedded in wage and price setting decisions, and thus reinforce upwards pressure on actual inflation. But we don’t think the RBNZ will, or should, be in panic mode just yet.

For starters, while the RBNZ would clearly prefer expectations closer to the 2% sweet spot, they’re still sitting comfortably within the 1–3% target band. And we don’t expect them to drift much further north. Headline inflation is still expected to ease over 2026, helped by spare capacity in the economy. The recent 3.1% print should mark the peak in this latest bout, with headline inflation cooling over the year and expectations following suit.

In the meantime though, the RBNZ will of course be keeping a close eye on expectations. Monitoring such like a rash from a bug bite. Not panicking, but checking to make sure it doesn’t spread beyond the red circle drawn around it. As long as expectations stay inside that boundary, and the mediumterm outlook remains one of cooling inflation, then we think the RBNZ can afford to watch carefully.

Special Topic: The lift in rates

Following the pop higher in wholesale rates, from November, the 2-year swap rate has consolidated at 3.07%, having hit 3.17%. That’s good news for homeowners looking to fix. Rates should be steady for now… assuming the RBNZ doesn’t fuel the rate hike fire.

Pricing for the RBNZ is still a little punchy. There is a full 25bp hike priced by October (2.51%), and a 70% chance (17/25) of another hike in December. The 2.67% in December is down from 2.79% priced just a few weeks back. Rate expectations remain elevated, compared to the fundamentals. But we will learn more on Wednesday. The RBNZ’s OCR will be lifted, to remove the small chance of another rate cut, and to pull forward rate hikes. Currently, there are a series of rate hikes priced from October. We believe we need to see the actual recovery take hold, and business investment take off… long before we advocate delivering higher rates. There has already been a significant tightening in financial conditions. Thoughts of further rate cuts (“out with the old chart”) have been replaced with hikes (“in with the new”). This is good news as the economy shows tentative signs of recovery. But the hikes implied, are too early.

This swing saw retail mortgage rates push higher. Sooner than we would have prescribed. It’s the RBNZ’s job to manage these expectations. Do we need rate hikes this year? It’s simply too early to know, with conviction. And the path of lest regret is to hold (until next year).

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