RBC: Will A Higher Kiwi Terminal OCR Drag RBA Pricing Higher?

RBC note that “the RBNZ hiked rates by 25bp to 1.00% at its MPS, in line with expectations and consistent with previous communication as it continues to normalise policy. The Statement erred hawkish from a number of perspectives and we make a few observations.”

• “Firstly, while there are limited changes to the near term 2022 OCR profile (OCR forecast largely unchanged at 2.2% end 2022), ~75bp of additional hikes are beyond that with terminal lifting to 3.4% in 2024 (from 2.6%). This is well above the RBNZ’s estimate of neutral (2%) and firmly in restrictive territory. Secondly, there was clearly some debate over a larger 50bp move today with the decision “finely balanced” and the Governor not ruling out 50bp quantum hikes in the future perhaps consistent with its least regrets approach to policy normalization. Thirdly, inflation forecasts have been revised up in both 2022 and 2023. The labour market is extremely tight with employment judged to be “above its maximum sustainable level”. Finally, while not new, active QT combined with a higher OCR profile points to considerably more tightening in financial conditions than previously flagged.”

“Today’s RBNZ decision and accompanying MPS will probably keep upward pressure on RBA market pricing. While wage and inflationary pressures are greater in NZ, Australia tends to be viewed (rightly or wrongly) through a similar lens by many market participants. The RBNZ has historically been more proactive though, and as such markets are likely to keep looking to the NZ market for a lead on Australia. A willingness to keep hiking into firmly restrictive territory and actively reduce bond holdings are all things the RBA isn’t yet up to, but which markets might see as a risk given the RBNZ lead. We’ve pointed in the past to upside risk in current RBA terminal rate pricing (currently about 2.5%), and this latest round of RBNZ communication only adds to this top-side pressure. The language on household debt is also notable, with the RBNZ happy to keep hiking despite the elevated level of debt - it notes 50% of all fixed mortgages will reset in 2022 to (likely) significantly higher levels while house price growth is likely to ease materially this year (RBNZ +6%) and fall modestly in 2023.”