Economic Weekly: Heading off the inflation sucker punch

When asked about strategy in the ring, the great Mike Tyson – up there with Adam Smith and J.M. Keynes as one of history’s great Economic sages – once said, “everybody’s got a plan until they get punched in the mouth.”

Until relatively recently, major central banks had similar plans for how they expected the next couple of years to play out. While the pandemic fallout hadn’t been as bad as feared in many parts of the world, the recovery would be a fragile thing and monetary policy would need to remain highly accommodative for some time as the labour market wended its way back to health. ‘Transitory’ factors would see inflation tick up over the short term, before once again abating. Rate hikes would come slowly and at a gradual pace. The RBNZ was very much part of this cohort.

Over the past couple of months, a succession of left and right jabs has meant those plans have gone out the window. For the RBNZ, the left punch here has been the resilience in the labour market, with the economy looking closer to full employment, much earlier than the Bank previously forecast. The right hook has been the continuing build up in inflationary pressures, culminating in the monster CPI result on Friday, which saw annual inflation hitting 3.3% (versus the RBNZ’s expectations of a 2.8% lift). Neither factor looks likely to throw in the towel any time soon – in particular, we expect headline inflation to approach 4% over the second half of the year as stretched capacity pressures linger.

Sure enough, we saw the RBNZ change tack and make a sharp hawkish turn at last Wednesday’s Monetary Policy Review (after some hints back in May), announcing the end of the Large-Scale Asset Purchase programme and excising wording around the ‘considerable time and patience’ the recovery would need. We now expect a swift one-two of 25bps OCR hikes in August and November.

Still, despite the change of plan, not all of our views have shifted dramatically. While there is some risk the Bank moves to quickly normalise policy, we still think it’s more likely to stick to a gradual pace given the lingering uncertainty – NSW’s mishandled outbreak of the Delta COVID variant shows there are clearly still downside risks remaining. And we continue to expect a relatively low OCR endpoint of 1.50%.

Still, the direction of travel is clear – wholesale and retail rates are past their lows and are likely to head higher, sooner than previously expected. For borrowers and savers, it’s a prudent time to review interest rate exposures and check you’ve got the right mix for your financial needs.