Three Factors Fuelling Early Rate Hike Expectations In New Zealand

SummaryThe central bank has recently decided to halt bond buying under its large-scale asset purchase program by 23 July.Several economists have brought forward their rate hike anticipations following the Reserve Bank’s decision.The recent performance of some economic indicators is pointing towards early interest rate rises by the central bank.

New Zealand’s economy has bounced back from the impact of the COVID-19 pandemic much faster than many other developed economies. Much of the credit goes to the country’s remarkable success in containing the COVID-19 spread and its geographical distance from most parts of the world. Meanwhile, the better than expected rebound in the country’s economy has fuelled market bets of an interest rate hike by the central bank as soon as next month.

The Reserve Bank of New Zealand (RBNZ) recently announced that it would halt bond buying under its large-scale asset purchase program by 23 July. The central bank’s decision to cease quantitative easing emerged as a surprise move for investors, sending the domestic currency higher as traders priced in early interest rate hike expectations.

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Following the central bank’s decision and considering economic revival prospects, several economists have brought forward their rate hike anticipations as early as August. Economists fear that the domestic economy is at risk of becoming dangerously overheated. In case the Reserve Bank follows through, New Zealand will become the first advanced economy across the globe to increase interest rates in August.

Let us quickly look at three economic factors that are fuelling chances of an earlier-than-expected interest rate hike in the country:

Inflationary Pressures Continue to Mount

As per the recently released figures by Statistics New Zealand, the country’s CPI (Consumer Price Index) rose at its fastest pace in about ten years in the second quarter of 2021. The annual inflation rate climbed to 3.3 percent in Q2 2021, surpassing analysts’ expectations of a 2.7 percent increase. Part of the annual increases in inflation numbers attributes to the fact that it was determined against the June 2020 quarter, a period affected by the COVID-19 lockdown.

Meanwhile, consumer prices advanced by 1.3 percent on a quarter-on-quarter basis, exceeding the median forecast of 0.7 percent. This quarterly gain was primarily led by higher prices for used cars, fuel, and house construction. Notably, the broad-based nature of inflationary pressures is quite evident in the June quarter CPI report card.

Also Read: Inflation makes NZ consumers worried, new data shows price rise to 3.3%

The country’s economy appears to be stoking inflation as strong demand has been allowing firms to pass on higher costs to consumers. Moreover, the looming labour shortage seems to be threatening to drive up wages. Given the scenario, it will be interesting to see how soon and how much the central bank will raise the cash rate this year.

Business Confidence Rebounds Sharply

The quarterly survey of business opinion (QSBO) undertaken by the New Zealand Institute of Economic Research (NZIER) showed that the country’s business confidence improved sharply in Q2 2021. Interestingly, a seasonally adjusted 10 percent of firms surveyed anticipated general business conditions to improve over the near term, relative to 8 percent pessimistic reading in the previous quarter.

Although a large number of firms expected general business conditions to improve, businesses also highlighted two significant constraints in the market – supply disruptions and lack of skilled labour. Meanwhile, an increasing number of firms accepted that they are finding it easier to pass on higher costs, pointing to rising inflationary pressures in the months ahead.

As per NZIER, the business confidence results suggest that the recovery in the country’s economy will remain robust in the coming year. In such a case, the RBNZ may not retain the record amounts of monetary stimulus to support the economy.

Labour Market Remains Tight

The country’s central bank has been supporting “maximum sustainable employment” as part of its remit for years. At a time when the labour market recovery is gathering momentum, several economists are affirming the view that the labour market is at maximum employment. This view stems from the fact that businesses are facing trouble finding both skilled and unskilled labour in the market.

Interestingly, the number of individuals receiving unemployment welfare has also continued to drop in the country. The recently announced government statistics reveal that more than 30,000 people no longer received a work-ready benefit in the June 2021 quarter. The statistics bucked the seasonal trend that usually sees an increase in benefit numbers over the June quarter.

Clearly, the labour market has become really tight in recent months as the country’s economy recovers from the virus crisis. Businesses may need to embrace higher wages to retain and attract staff in this tight labour market, which can spark further price increases in the economy.

Barring any additional economic shocks, the current scenario is pointing towards building up further inflationary pressures in the economy in the months ahead. Having said that, the timing and pace of interest rate increases by the central bank will depend on these inflationary forces and the level of underutilised labour.