Increase in cash rate
The Reserve Bank has increased the official cash rate (OCR) to one per cent from 0.75 per cent and will start reducing its bond holdings through bond maturities and managed sales.
Its monetary policy committee agreed the bank should continue reducing monetary stimulus to help reduce inflation, which is now 5.9 per cent.
In his statement accompanying the bank’s first monetary policy statement of 2022, Orr says economic capacity pressures have tightened, with employment now above its maximum sustainable level and other indicators showing the economy is performing above its current potential.
Orr notes headline CPI inflation is well-above the bank’s one-to-three per cent target range, but it will return to the two per cent midpoint over the coming years.
He says: “The near-term rise in inflation is accentuated by higher oil prices, rising transport costs and supply shortfalls. These immediate relative price movements risk generating more generalised price rises, especially given current domestic capacity constraints.”
February’s monetary policy statement adds significant government and monetary support around the world has helped to avoid prolonged negative impacts from the coronavirus pandemic.
“However, this robust demand has not been met with sufficient global supply due to continued Covid-19 outbreaks, related restrictions and shipping disruptions,” it says. “These factors have created an inflationary environment globally. As New Zealand is a small open economy, we are directly impacted by these developments.”
The committee confirms house prices are above sustainable levels but should ease over time. “Government regulatory and tax-policy changes and high rates of residential building are expected to slow house prices. Higher mortgage-interest rates will also play a role in the transition of house prices toward a more sustainable level over coming years.”
The OCR remains the committee’s preferred tool for implementing monetary policy, but it also agreed to the managed sale of bond holdings acquired under the large-scale assets purchase programme, as well as not investing the proceeds of bonds that mature.
“In doing so, the committee applied their least-regrets framework, noting the most significant risk to be avoided was longer-term inflation expectations rising above the target and becoming embedded in future price-setting.”
The record of the meeting makes it clear committee members were divided between raising the OCR by 25 or 50 basis points. When deciding on the smaller rise, they noted interest rates increased significantly late last year and would continue to rise as the OCR went up. Also, sales of the bank’s bond holdings from large-scale asset purchases may put upward pressure on long-term interest rates.
The committee warns it’s willing to increase the OCR in larger increments if needed over coming quarters. In the monetary policy statement, it projects the OCR to go higher than anticipated in November’s statement, heading above three per cent by 2024. The Reserve Bank estimates the nominal neutral interest rate to be around two per cent.
Orr says the bank is mindful about the likely impact of the omicron outbreak, which is expected to peak over the next few weeks or so. But there’s no expectation the economy will take the sort of hit it did in 2020 when the pandemic first hit because the borders are reopening, restrictions are easing and the population is highly vaccinated.
