RBNZ Signals High Probability of December Rate Hike After Surprise Hold

What happened

The Reserve Bank of New Zealand (RBNZ) surprised markets by holding its official cash rate at 2.75% on Wednesday. However, a day later, Governor Anna Breman stated in an interview with the New Zealand Herald that the chances of a rate hike in December are high. She clarified that all monetary policy committee members agree that further rate increases are likely, though the exact timing depends on the economic outlook and inflation developments. The previous decision to hold rates was a close call, with a 4-3 split in the committee, and Breman was among the majority who argued for more time to assess the effects of the two recent rate increases.

Why it matters

Governor Breman's communication is an effort to push back against the 'dovish' reading the market took from the rate hold and to steady the New Zealand dollar, which fell sharply after the initial announcement. A weaker dollar could exacerbate imported inflation, especially in a context of rising fuel prices. The signal of a likely December hike, with markets now pricing around a 77% chance, suggests the RBNZ is keen to anchor inflation expectations and maintain its credibility in combating rising prices. Recent data, such as a business survey showing more firms planning to raise prices, reinforces this concern.

Market impact

• Interest rates and bonds: The expectation of a December hike tends to push up New Zealand's short-term bond yields, reflecting the pricing in of a higher borrowing cost. The uncertainty about the exact timing, however, may limit a sharper rise in longer-term yields.
• Dollar and exchange rates: The New Zealand dollar (NZD) tends to strengthen against other currencies, recovering some of the losses incurred after the rate hold. The prospect of higher interest rates makes the NZD more attractive to investors seeking yield. However, the recovery may be gradual, as Governor Breman emphasized that the timing remains uncertain.
• Equities: New Zealand's stock markets may face negative pressure, as higher interest rates increase the cost of capital for companies and could slow economic growth. Sectors more sensitive to interest rates, such as technology and real estate, may be more affected.
• Commodities: The relationship is indirect. If the RBNZ's signal is interpreted as a sign that other central banks may also need to be more aggressive in combating inflation, this could, in theory, lead to a strengthening of the US dollar, which, in turn, would tend to put downward pressure on dollar-denominated commodity prices. However, the main external swing factor mentioned is fuel prices, linked to the Iran conflict, which adds complexity.
• Brazil: The direct impact is limited, but a global scenario of more hawkish central banks could influence global risk sentiment. This might lead to increased risk aversion, with capital outflows from emerging markets, including Brazil, which would tend to put pressure on the real and local interest rates.

What to watch

Upcoming inflation and labor market data in New Zealand will be crucial to confirm or invalidate the likelihood of a December hike. Additionally, the behavior of the New Zealand dollar and fuel prices, which are a significant external factor, will be closely monitored. The December decision will come alongside the Monetary Policy Statement, which will include updated forecasts and a new projected path for the cash rate.

Scenarios

Base Case: The RBNZ raises interest rates in December, driven by persistent inflation data and a weak New Zealand dollar, stabilizing the currency and anchoring price expectations. Risk Scenario: The RBNZ holds rates in December due to an unexpected economic slowdown or a drop in oil prices, leading to further NZD depreciation and concerns about the central bank's credibility.

Original source: ForexLive (InvestingLive). For information only, not investment advice.