Tough call for Reserve Bank but rate hike expected despite economic blow from Cyclone Gabrielle

Reserve Bank Governor Adrian Orr is expected to continue the fight against inflation. Photo / Mark Mitchell, Herald montage

With the economy facing a major new challenge, Reserve Bank Governor Adrian Orr faces a tough task communicating the Reserve Bank’s monetary policy strategy this Wednesday.

The RBNZ is widely expected to lift the official cash rate by 50 basis points - to 4.75 per cent - despite the billions of damage the economy faces after Cyclone Gabrielle.

“Given the current high inflation environment, the RBNZ faces a difficult choice, said ANZ economist Finn Robinson.

“Continuing to aggressively hike rates to counter high inflation will further impact people who are really struggling right now.

Under normal circumstances, the RBNZ might have been able to look through the inflationary shock from an event like this, but these were not normal times, Robinson said.

“If they go easy on inflation and let inflation pressures reaccelerate, then they could end up causing even more interest rate pain later as they struggle to get back on the front foot in the fight against inflation.”

“There’s not much monetary policy can do to help in an event like this the response is best left to fiscal policy, which is faster acting and can be targeted where it’s needed most.”

The RBNZ could potentially help out fiscal policy by slowing the pace of quantitative tightening, lightening the Government’s financing burden, ANZ said.

Finance minister Grant Robertson has already indicated there will be a strong fiscal response required to cope with the disaster and subsequent rebuild.

Early estimates have the total bill running to around $13 billion (although that includes costs covered by insurance).

Regardless the are expectations that the Government will need to re-assess its Budget plans and potentially adjust its debt track to account for costs.

The international financial market has largely taken the event in its stride so far.

The kiwi dollar has traded down 2c against the greenback in the past week (to US62c) although much of that movement has been driven by changes to US interest rate expectations.

The dollar would likely fall further if the RBNZ did decide to ease back on rate hikes.

But even Kiwibank economists (who argue that rate rises should go on hold while cyclone damage is assessed) acknowledge that a 50 basis point hike remains the most likely scenario.

Kiwibank chief economist Jarrod Kerr has argued that global inflation pressure has eased enough to allow the RBNZ to pause until April.

“The need to tighten aggressively from here has evaporated. Inflation is peaking at lower levels. And global inflation pressures are abating,” he said.

Currently, at 7.2 per cent, inflation was below the RBNZ forecast of 7.5 per cent and the balance of risks was tilted to the downside.

“Current circumstances warrant caution. But what we think they should do is not what they will likely do. We expect to see a hike, but the discussion should be around 0 or 25bps, not 50 or 75bps.”

A 50-point hike would be a tough call for the RBNZ to make in the face of an ongoing national state of emergency, he said.

Finance Minister Grant Robertson takes in the damage caused by Cyclone Gabrielle during a tour of Taylor Corp Orchard and Packhouse in Waiohiki, Taradale. Photo / Mark Mitchell

“If the RBNZ does decide to hold, we will see some volatility for the Kiwi dollar.”

Markets have priced in a slight chance that RBNZ will opt for a smaller 25 basis point hike.

“If the economic impacts look set to be significant, the RBNZ will better account for them in its April and May economic assessments,” said ASB chief economist Nick Tuffley.

Gisborne and Hawke’s Bay, both badly affected, account for around 3.5 per cent of GDP between them, Tuffley noted.

The RBNZ had, on three occasions, cut interest rates after unusual shocks that risked creating uncertainty and pauses in spending decisions: the 9/11 terror attacks, the February 2011 earthquake (but not the September 2010 earthquake) and the early stages of the COVID pandemic, he said.

“Although the weather disasters are devastating to those directly affected, a confidence knock to activity looks much less likely. And the starting point for inflation is one of red-hot pressure,” he said.

The overall impact of the disasters would be a boost in inflation, mainly over the next 3-6 months.

“We expect the RBNZ will look through the inflationary impacts of the storms, though the job of distinguishing underlying inflation pressures from more transient storm effects will be a challenge.”

The Government can be much more effective at targeting support at those with genuine need, with key support mechanisms (such as business support, wage subsidies) already established, he said.

The messaging for the April decision now looked more difficult.

“We expect a further 50bp increase in April, though it is possible the RBNZ moves to smaller 25bp steps as the RBNZ starts thinking about fine-tuning the end of the tightening cycle,” Tuffley said.

At some point, the RBNZ would need to signal it is pausing: an on-hold stance contingent on inflation pressures continuing to ease at an acceptable pace.

“It’s hard to do that without creating a market stampede to price in OCR cuts that undermine the tightening the RBNZ will want to keep in place.”