The Reserve Bank of New Zealand on Wednesday raised interest rates by 25 basis points to 0.75% as it moves to cool off the economy and rein in soaring house prices.
The RBNZ’s aggressive interest rate hike will be closely watched by central banks around the world as they consider how to react to the global price increase.
The RBNZ thinks the neutral rate – which monetary policy will not stimulate or constrain the economy – is around 2%. Its new forecast suggests the rate will have to rise to 2.6% by December 2023, from the 2.1% it forecast in August.
That suggests the bank thinks the economy will overheat for a while and that it will have to use restrictive policy to get inflation back on track.
Capacity pressures in New Zealand are becoming increasingly acute. The RBNZ expects the consumer price index to rise above 5% in the near term before returning to an average of 2% within its target range by the end of 2023.
The New Zealand central bank is unusual from the others in that both inflation and employment are at or above their target level, which has put pressure on the central bank to reduce monetary stimulus.
The RBNZ assesses that the recent increase in inflation is driven by higher oil prices, rising transport costs and the impact of supply shortages. It notes that there is a risk that such shocks will generate larger price increases due to constraints on domestic production capacity.
At the board meeting, the RBNZ discussed the case for a larger rate hike because of capacity pressures, a higher starting point for inflation and the risk that near-term inflation will turn into pricing behavior. .
But they decided not to do so because of uncertainty about the resilience of consumer spending and business investment as New Zealand adapts to living with the Covid-19 virus. Until recently, Wellington pursued a zero-Covid policy.
Another reason is that monetary conditions have tightened as banks raise interest rates for households and businesses.
The RBNZ discussed the stimulus provided by the lingering effects of the asset purchase program and said it expected to reduce its bond holdings. It will provide details early next year.
In its forward guidance, the RBNZ said: “Further removal of monetary policy stimulus is expected over time based on the medium-term outlook for inflation and employment.”