August 19, 2021

COVID-19 lockdown holds off OCR rise…for now

Reserve Bank Governor talks of OCR at two percent within a year

In a move most were not expecting just 24 hours earlier, the Reserve Bank of New Zealand (RBNZ) has kept the official cash rate (OCR) at 0.25 percent.

Expectations were that RBNZ would increase the OCR to 0.5 or even 0.75 percent. However, the heightened uncertainty resulting from the Government’s imposition of Level 4 COVID-19 restrictions on activity across New Zealand has seen RBNZ take a sensibly cautious approach.

The decision to hold the OCR at 0.25 percent means that if New Zealand can move back down alert levels and economic activity can quickly resume with minimal disruption inflation concerns mean OCR increases almost certain when lockdowns ease.

New Zealand’s strong recovery from the initial COVID-19 lockdowns has seen the economy rebound faster than most, including this author, expected. RBNZ views employment as at or above its maximum sustainable level, while unemployment has fallen to the long term average of four percent. RBNZ expect unemployment to fall further, forecasting unemployment to fall under four percent next year.

With the OCR set to keep interest rates lower than expected in the short term, inflation remains a concern. Annual Consumer Price Index (CPI) inflation has increased to 3.3 percent due to capacity pressures on resources, high housing demand, supply-chain disruptions and global oil price increases. RBNZ expects the higher inflation to remain above the one to three percent target band and increase further in the near term to push above four percent, before returning towards the two percent midpoint of the target band from mid-2022.

Despite RBNZ forecasts expecting inflationary pressures to be temporary, uncertainty remains as to whether recent and expected high inflation will become embedded in prices and wages. If it becomes imbedded, it could lead to continued inflationary pressures, putting pressure on RBNZ to increase the OCR further and earlier than currently expected.

How high will the OCR go?

RBNZ is confident of meeting its inflation and employment remits with less need for the existing level of monetary stimulus. RBNZ forecasts see the OCR increasing earlier than expected at the time of the May OCR announcement, when it did not expect any OCR increase until the middle of 2022. Updated forecasts indicate it will raise the OCR to one percent in the first half of next year and then to around two percent in 2023 and 2024. This is consistent with a neutral OCR where it is neither stimulatory nor contractionary, when extreme measures, like those we have seen recently, are no longer required.

BERL is of the view that if the current lockdown can end quickly and normal activity can resume with a limited impact on the economy, higher inflation is more likely to be lasting than it is to be temporary. RBNZ Governor Adrian Orr has expressed the view that, depending on what happens to inflation, the OCR could rise to two percent by the end of 2022. For this reason, we expect to see several fairly aggressive increases in the OCR, once the latest outbreak of COVID-19 in New Zealand is under control.

If you want to know more about inflation, and BERL’s expectations, the forthcoming Birds Eye View will have a special feature. Sign up to BERL’s Monthly Monitor below to join the mailing list.