Reserve Bank raises OCR to 2 per cent as it seeks to smack down inflation

The Reserve Bank of New Zealand (RBNZ) has come out swinging, pledging to do what it takes to smack down inflation.

The central bank on Wednesday lifted the official cash rate (OCR) by 50 points to 2 per cent, as was widely expected.

However, it forecasted lifting the rate much more aggressively than when it last reviewed monetary policy in April.

Back then, the RBNZ saw the OCR peaking at around 3.4 per cent by September 2024. Now, it sees the rate peaking at 3.9 per cent in June 2023.

Recent homebuyers and those with a lot of debt will feel the pain, unemployment will rise and economic growth will be relatively slow. But the RBNZ believes its actions won't cause a recession.

With annual inflation hitting a three-decade high of 6.9 per cent in the March quarter, the RBNZ said it was "resolute in its commitment" to bringing inflation back within its 1 to 3 per cent target range.

It recognised the impacts Russia's invasion of Ukraine and Covid-19 were having on oil prices and supply chains – factors beyond its control. But it also said government spending in response to Covid-19 has made a "modest" contribution towards demand.

The RBNZ said it would rather risk doing "too much too soon" to lower inflation, than risk moving "too slowly and not far enough".

It acknowledged the risk of it taking a "least regrets" approach was this would put pressure on some households' spending decisions – especially those that are highly indebted.

It also forecasted house prices falling by 14 per cent between their peak in November 2021 and early-2024.

While this would be a large fall by historic standards, the RBNZ said prices would need to fall by 30 per cent from their peak to take them back to pre-pandemic levels.

Accordingly, it said many homeowners have "significant equity buffers".

Only around 1 per cent would be in negative equity if the RBNZ's house price forecasts came to fruition. If prices fell by 30 per cent, 10 per cent of housing debt would be in negative equity.

The RBNZ said another mitigating factor is that as a collective, households' savings increased during the Covid-19 period – in part thanks to government support and in part thanks to the fact people haven't been able to spend on overseas holidays.

While this contributes towards higher domestic demand, it also puts households on a strong footing in the face of rising interest rates.

But, the RBNZ was clear – those with a lot of debt, including recent first-home buyers, will struggle.

It estimated that a median-income household, buying a median-income home will now spend 58 per cent of their disposable income on mortgage repayments. This figure fell to 33 per cent in 2020, and was last near the 60 per cent mark in 2008.

Looking ahead, the RBNZ expected a "noticeable" number of households that borrowed for the first time in 2021 to find it difficult to cover their living costs, should 1 and 2-year mortgage rates reach 6 per cent in the next year, as expected.

The RBNZ noted banks tested mortgage applicants at interest rates of around 6 per cent during the Covid-19 period.

Banks are now testing to see if mortgage applicants can service debt at above 7 per cent.

The RBNZ made another key point – the pain of a higher OCR, and thus higher mortgage rates, is yet to be felt across the economy.

It said the average rate across the country's stock of mortgages is currently only 3.1 per cent, and is set to rise to 5.3 per cent in the next year as borrowers refix their mortgages.