RBNZ Signals 'Highly Likely' Rate Hikes Despite Hold

What happened

Reserve Bank of New Zealand (RBNZ) Governor Anna Breman stated that further increases in the Official Cash Rate (OCR) are 'highly likely' at coming meetings. This statement follows a 4-3 vote by policymakers to leave rates unchanged at their most recent meeting. Breman justified the outlook for future hikes by pointing to anchored inflation expectations, subdued wage growth, and weak domestic demand.

Why it matters

The RBNZ Governor's signal is crucial because, despite a pause in rate hikes, the central bank maintains a hawkish stance. The split 4-3 decision to keep rates unchanged suggests that internal discussions about the need for further monetary tightening are intense. The Governor's remarks, even while mentioning factors that could justify a pause (anchored inflation expectations, wages, and weak demand), reinforce the prevailing concern about inflation. This indicates that the RBNZ is prepared to act again if conditions warrant, challenging the perception that the pause might be the end of the tightening cycle.

Market impact

• Interest rates and bonds: New Zealand government bond (NZGB) yields are likely to rise, especially at shorter maturities, reflecting expectations of future OCR hikes. The yield curve may steepen or shift upwards as investors price in a longer or more aggressive tightening cycle than initially anticipated.
• Dollar and exchange rates: The New Zealand dollar (NZD) is likely to strengthen against other currencies. The prospect of higher interest rates makes NZD-denominated assets more attractive to yield-seeking investors, increasing demand for the currency. This could be particularly noticeable against currencies of countries where central banks are signaling pauses or cuts.
• Equities: The New Zealand stock market may experience downward pressure. Higher interest rates increase borrowing costs for companies and can reduce asset valuations, particularly for growth companies reliant on cheap capital. Sectors most sensitive to interest rates, such as real estate and technology, may be more affected.
• Commodities: The direct impact on commodities tends to be limited, unless New Zealand is a significant producer or consumer of a specific commodity. However, a stronger NZD can make imported commodities cheaper for New Zealand and exported ones more expensive for foreign buyers, affecting the trade balance.
• Brazil: The direct impact on Brazil is marginal. However, in a global scenario where central banks maintain a hawkish stance, global risk aversion may increase. This, in turn, could lead to capital outflows from emerging markets, including Brazil, putting pressure on the real and the Ibovespa, although the effect would be secondary and indirect.

What to watch

Investors should closely monitor upcoming New Zealand economic data, focusing on: inflation reports (CPI), labor market data (especially wage growth), consumer and business confidence surveys, and indicators of economic activity. Any signs of accelerating inflation or resilient demand could solidify expectations for further rate hikes. Additionally, minutes from future RBNZ meetings and any further speeches by Governor Breman or other board members will be crucial for understanding the central bank's evolving thinking.

Scenarios

Base case: The RBNZ implements one or two more rate hikes in the coming months, leading to a stronger NZD and higher bond yields, while the economy gradually slows. Inflation remains persistent but under control. Risk scenario: Inflation proves more stubborn than anticipated, forcing the RBNZ into a more aggressive tightening cycle, which could lead to a sharper economic slowdown or even a recession. Alternatively, domestic demand weakens rapidly, prompting the RBNZ to re-evaluate its hawkish stance sooner than expected. Original source: Bloomberg Markets. For information only, not investment advice.