Wed. Dec 1st, 2021

The Reserve Bank of New Zealand on Wednesday raised interest rates by 25 basis points to 0.75 per cent as it moved to take the heat out of the economy and keep rising house prices in check.

In announcing his second rate increase in two months, the central bank also gave falcons guidance on future moves, saying interest rates are likely to rise above their neutral level.

The RBNZ’s aggressive campaign of rate hikes will be closely watched by central banks around the world as they consider how to respond to a global rise in prices.

The RBNZ thinks the neutral level of interest rates – at which monetary policy will not stimulate or limit the economy – is about 2 percent. Its new forecasts suggest that rates will have to rise to 2.6 percent by December 2023, compared to the 2.1 percent it predicted in August.

This suggests that the bank thinks the economy will run too hot for a period of time and it will have to use restrictive policies to get inflation back on track.

Capacity pressure in New Zealand has worsened. The RBNZ expects the consumer price index to rise above 5 percent in the near term before returning to the 2 percent center of its target range by the end of 2023.

New Zealand’s central bank is unusual among its peers in that both inflation and employment run at or above target levels, which has put pressure on the central bank to reduce monetary stimulus.

The RBNZ judged that the short-term rise in inflation was accentuated by higher oil prices, rising transport costs and the impact of supply shortages. There is a risk that those shocks will cause larger price increases given domestic capacity constraints, he noted.

At the board meeting, the RBNZ discussed the issue for a larger rate hike due to capacity pressure, the higher starting point for inflation and the risk that inflation would become embedded in pricing behavior in the short term.

But it chose not to do so due to uncertainty about the resilience of consumer spending and business investment, as New Zealand adapts to live with the Covid-19 virus. Wellington until recently pursued a zero-covid policy.

Another reason was the tightening in monetary conditions that has already taken place as banks raise interest rates on households and businesses.

The RBNZ discussed the stimulus provided by the ongoing impact of its asset buying program and said it expects to reduce its bond holdings. It will provide details early next year.

In its forward-looking guidance, the RBNZ said: “Further removal of monetary policy stimulus is expected over time given the medium-term outlook for inflation and employment.”

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