OCR decision: How high will the Reserve Bank take the official cash rate?

The Reserve Bank is expected to hike the official cash rate (OCR) on Wednesday as New Zealand experiences the highest level of inflation in decades.

After sitting at 0.25 percent for months during the pandemic, a series of consecutive 25 basis point increases since October last year has seen the OCR reach 1 percent and it's widely anticipated to continue to rise, likely meaning a jump in interest rates.

In its preview of the decision, ANZ said the Reserve Bank needed to make a big move to "rein in runaway inflation" and the "sooner they rip into it, the lower the economic cost is likely to be". 

It's predicting a 50 basis point increase, which would be the largest increase to the OCR since May 2000. Normally jumps to the OCR come in 0.25 basis point stages, though the central bank does make bigger moves pulling it down, such as a -1.50 basis point move during the height of the global financial crisis and -0.75 basis points at the start of the COVID-19 pandemic. 

"The Reserve Bank is between something of a rock and a hard place," ANZ said in its report. 

"On the one hand, the path ahead for the economy is looking anything but smooth, with house prices falling and consumer confidence pummelled as household budgets are squeezed. On the other hand, the wall of inflation is vertical and so far, completely unyielding.

"Normally, near-term downside growth risks are a recipe for at least caution on the part of central banks, if not outright largesse. But this time, one key thing is very, very different – inflation."

There are risks to raising the OCR in large increments, mostly with the housing market, ANZ said, but "the RBNZ now has to play the hand it's got". 

Reserve Bank Governor Adrian Orr.
Reserve Bank Governor Adrian Orr. Photo credit: Getty Images.

StatsNZ revealed in January that inflation in the year to December 2021 had hit 5.9 percent, the highest annual increase since 1990. That's far beyond the Reserve Bank's objective of keeping inflation between 1 and 3 percent on average while also supporting maximum sustainable employment.

Commentators only expect inflation to worsen given the Omicron outbreak and the war in Ukraine. ANZ is forecasting it could reach 7.4 percent in the second quarter of the year. 

While it's difficult to pinpoint where inflation may fall during the first quarter of the year, which will take into account the Russian invasion, New Zealand's response to Omicron and continued supply chains issues impacting imports and exports, ANZ said it's largely a moot point. 

"Inflation is far too high. Core inflation is far too high. Inflation expectations are far too high. And firms' pricing intentions, which have been the best inflation indicator of all, are stratospheric and at this point, still rising."

ANZ's Business Outlook in March found inflation could be "moon-bound" given that nearly all surveyed businesses expected higher costs in the coming months, which flows on to increases in prices for consumers. 

Meanwhile, ASB is forecasting a more cautious 25 basis point jump, but isn't ruling out the possibility of a larger increase.

"Next Wednesday looms as one of its more eagerly awaited OCR decisions. It is clear that the OCR needs to go up. The inflation outlook, while highly uncertain over the medium term, is worryingly high at present. The labour market is tight as a drum."

It said commentators are on the fence over how big the jump will be but is opting for 25 basis points with the expectation the Reserve Bank will "deliver an upfront assessment reiterating that the tightening cycle is still in its early stages, that follow-up 50 basis point hikes (notably in May) are still possible and that the OCR will need to move above neutral levels to achieve the RBNZ’s objectives".

"This should help mitigate immediate financial market reaction from 'just' a 25bp move and largely sustain the tightening in financial conditions that the RBNZ has already engineered. 

"For now, we are sticking to our call for a sequential path of 25bp hikes and a 2.75 percent early 2023 OCR peak. A lot can change, however, and a more strident path of OCR hikes in 2022 and then OCR cuts in 2023/24 is a distinct possibility."

BNZ agrees it's a "coin toss" but is leaning towards 25 basis points as well.

"Were the RBNZ to hike 50 basis points in April, then we have little doubt the market would fully price a further 50 basis points for May and, most likely push the terminal rate through 4 percent."

That may have a bigger impact on the housing market than what would be desirable, the bank said. 

"A further 25 point nudge in the cash rate, accompanied by a stern warning that a more aggressive interest rate track will likely be forthcoming, when it releases its May Monetary Policy Statement, might be a better approach."

Westpac also believes it will be a 25 basis point lift. 

"As in February, it’s likely to be a tough call between a 25bp and a 50bp hike. That decision won’t be helped by the unusually light data flow between reviews," the banks says.

"The data that we have had suggests that near-term inflation is a growing headache for businesses and households. But it also shows that monetary policy moves to date are getting the intended traction via the housing market."