STEADY DOES IT: RBNZ’S PREFERENCE FOR 50 BASIS POINT HIKES THUS FAR

The RBNZ have resorted to five successive 50 bps hikes after starting the tightening process with three 25 bps hikes, in a balanced attempt to cool inflation while avoiding a massive shock to the economy.

New Zealand Official Cash Rate (OCR) Over Time

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Source: Refinitiv, prepared by Richard Snow

RBNZ Minutes of the October 5th Meeting

In the last meeting, the monetary policy committee (MPC) considered 50 or 75 basis points, much like they will ahead of tomorrow’s announcement. Arguments in favor of both outcomes were discussed as some members highlighted that a larger increase in the OCR now would reduce the likelihood of a higher terminal rate further down the line. On a more dovish note, members were also cognizant of the lagging nature of existing hikes while noting that bank funding costs are expected to become less accommodative.

Additionally, GDP data for Q3 was still being compiled at the time of the meeting (although the MPC has a good idea of the figures) and the economy was coming off a 0.2% contraction - not exactly appropriate for larger than normal hike in October.

SO WHY IS THE RBNZ CONSIDERING A 75 BASIS POINT HIKE TOMORROW?

The answer to that question is unsurprisingly, data. Since the October meeting, inflation produced a massive surprise to the upside, beating forecasts of 6.6% as the level of general prices rose 7.2%. The actual figure is still lower than the prior 7.3% print but the deviation from expectations proves that the fight against inflation isn’t over.

New Zealand Inflation Alongside Selected Major Economies Remains Elevated

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Source: Refinitiv, prepared by Richard Snow

WAGE GROWTH AND INFLATION EXPECTATIONS REVISED HIGHER

Sticking with inflation, the RBNZ conducted its Survey of Expectations in October which unveiled that the one-year and two-year-ahead expectations increased to 5.08% and 3.62%, respectively – both well above the 1-3% target. Central banks pay close attention to medium to long term inflation expectations due to the risk of such expectations becoming de-anchored from central bank targets.

If employees and businesses envision higher inflation for longer, workers will lobby for higher wages and businesses will pass on higher operating and input costs to consumers in what can become a ‘wage-price spiral’. The RBNZ already envisions wage growth of 5.34% in the coming year, which is slightly above the one-year ahead expectation and could pose a challenge to bringing down the general level of prices. The chart below shows that New Zealand will lead the rest of the developed world if the 75 basis point hike materializes (4.25%).

Major Central Bank Policy Rates (NZ in Dark Blue)

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Source: Refinitiv, prepared by Richard Snow

Higher current and future inflation as well as higher wage growth, coupled with very low unemployment and reasonable GDP could see the MPC hike by 75 basis points tomorrow. Something to keep in mind is the declining property sector and the effect of Chinese lockdowns on NZ exports as the rate of Chinese infections approach the April 2022 peak. Higher NZ mortgage rates have resulted in a steady decline in house prices throughout the year with the New Zealand house price index down nearly 10%. Should members of the MPC stress the risks associated with increasing Chinese lockdowns, the committee may very well decide on another 50 bps hike while relying on hawkish guidance to reiterate that inflation remains too high.

(Click on image to enlarge)

Source: qv.co.nz, prepared by Richard Snow

NEW ZEALAND DOLLAR ANALYSIS: A SCENARIO-BASED APPROACH (AUD/NZD)

Market implied probabilities imply a 67% chance of a 75 basis point hike as opposed to 33% for 50 bps – which could work against the Kiwi dollar should we see the less likely 50 bps decided.

Such an outcome could play out via a pullback in the AUD/NZD pair, which sold off heavily since the RBA’s dovish 25 bps hike on the 4th of October and appears oversold on the RSI. The first level of resistance is the prior lower low around 1.0885, followed by the 1.0960 zone of resistance. However, such levels are rather far from current price action, reinforcing the strength of the resulting bearish move.

A 75 basis point hike may see a continuation of the bearish price action, although the bearish move appears rather stretched at current levels. On the daily chart, price currently tests the 1.0880 level, with the next level of support at 1.0675, followed by 1.0620.

AUD/NZD Daily Chart

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Source: TradingView, prepared by Richard Snow

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