RBNZ raises rates to 2.75% but signals shallower tightening path

The Reserve Bank of New Zealand increased its official cash rate by 25 basis points to 2.75% on Wednesday, as anticipated by market observers, but indicated a less aggressive path forward, leading the kiwi to drop sharply. The New Zealand dollar's NZD/USD pair fell approximately 0.6% to 0.586 following the decision, while the NZX 50 remained relatively unchanged, slipping around 0.1% to 13,778.87.

The stronger reaction in the New Zealand dollar was due to the Reserve Bank of New Zealand's (RBNZ) indication that additional rate hikes could still occur but are not assured. This marked the second consecutive rate increase and the second hike this year, following the RBNZ's 25 basis point hike in July. Prior to that, the bank had maintained the rate at 2.25% at its February, April, and May meetings.

Inflation remains the primary driver for the rate hikes. New Zealand's annual consumer-price inflation reached 4.1% in the June quarter, primarily because of higher fuel and related prices stemming from the Middle East conflict. However, inflation when excluding vehicle fuels slowed to 2.9%, with most underlying inflation measures still within the RBNZ's 1%-3% target range.

The central bank anticipates that inflation will stay high this year before returning to the target band by mid-2027 and hitting the 2% midpoint later in the year.

The RBNZ suggested gradually removing monetary stimulus and noted that the cash rate may need further increases, contingent on its economic outlook. However, it emphasized that the future path was not fixed and would depend on forthcoming data and the balance of inflation risks. This softer guidance was the main reason for the market's reaction.

Capital Economics stated that the RBNZ's message appeared "a bit less hawkish than before," pointing out that their July statement suggested further increases were probable at upcoming meetings. The brokerage still expects another hike in the fourth quarter but anticipates the cash rate peaking at 3.25% in the first half of 2027, lower than the market's expectation of a 3.75% terminal rate by year-end.

Furthermore, the RBNZ reduced its projected average cash rate for the fourth quarter to 2.81% from 2.84%, reinforcing the belief that the tightening cycle will be relatively mild.

Despite the RBNZ's more cautious assessment of inflation, the softer rate outlook was still released. The central bank pointed out that persistent energy and petrochemical prices could impact domestic price-setting and potentially make inflation more persistent. Some members of the bank also saw upside risks to inflation. Meanwhile, the New Zealand economy still has some room for growth.

The RBNZ stated that growth was sluggish in the second quarter but expected to rebound in the third, driven by resilient trading-partner demand and robust export prices.

New Zealand's Reserve Bank's next policy decision is scheduled for October 28, and investors are now likely to concentrate on whether incoming inflation and activity data warrant another increase later this year.