You can go your own way

As was widely expected, the Reserve Bank lifted the Official Cash Rate to 2.75% last week, and signalled an extended series of hikes over the course of the next few years. The subsequent market reaction will give the RBNZ some comfort that it can proceed with this plan: while the New Zealand dollar ended the week a little higher, it was in proportion with the firmer than expected tone of the Monetary Policy Statement.

The language of the MPS was noticeably more assertive than even the previous statement in January. The RBNZ noted that the economy’s expansion is “becoming more broad-based”, that inflation pressures are not just “expected to increase” but are now “becoming apparent”, and that “it is important that inflation expectations remain contained”. While the RBNZ stressed the need for interest rates to rise, it couched this in terms of removing stimulus rather than a tightening of policy, aimed at keeping the economy’s upswing at a sustainable pace.

The RBNZ has lifted its GDP growth forecast for this year to around 3.5%. Part of the increase comes from a stronger assessment of the economy’s potential growth over the next few years – the result of higher migration, higher labour force participation, and recent revisions to GDP showing that investment in capital equipment over recent years has been greater than thought. Even so, the RBNZ judges that the level of GDP is already running almost 1% above its non-inflationary potential, and the gap is expected to widen further as the economy expands and the Christchurch rebuild shifts into top gear.

The other significant change was in the RBNZ’s inflation forecasts, particularly for this year. Whereas the December MPS concluded that annual inflation wouldn’t reach the 2% midpoint of the RBNZ’s target range until the end of 2015, inflation is now expected to hit that mark by the middle of this year, and to remain just a touch below it over the following year. Given that the RBNZ’s current Policy Targets Agreement puts an increased emphasis on that 2% midpoint, and that surveyed expectations of inflation have been tending to drift up and away from the 2% mark, that leaves little room for complacency.