New Zealand keeps rates on hold but warns hikes may not be over

By Lucy Craymer

WELLINGTON (Reuters) - New Zealand's central bank held the cash rate steady on Wednesday, but noted inflation remained too high and that further policy tightening might be needed if price pressures did not ease.

The Reserve Bank of New Zealand (RBNZ) kept the official cash rate (OCR) at 5.5% as expected, but the hawkish tone of the statement surprised many in the market, pushing the New Zealand dollar and bond yields higher.

While the central bank said it was confident the current level of rates was restrictive, persistent demand and price pressures were of concern given the elevated level of core inflation.

"If inflationary pressures were to be stronger than anticipated, the OCR would likely need to increase further," it said in a statement.

The RBNZ decision is the first since New Zealand elected a new government headed by Prime Minister Christopher Luxon last month, following a campaign in which the central bank came under heavy political scrutiny.

The new centre-right government said on Wednesday it would start the legislative process to return the central bank to a single inflation targeting mandate in its first 100 days in office.

That change would remove the requirement for the RBNZ to consider employment when setting the cash rate and focus solely on inflation.

RBNZ Governor Adrian Orr told a media conference on Wednesday he had met with Luxon and new finance minister Nicola Willis on Tuesday, describing talks as "incredibly constructive" and focused.

"The number one job in hand for us is to reduce inflation," he said. He added the bank had not been consulted on returning to a single mandate but expected it would be.

New Zealand's annual inflation has come off in recent quarters and is currently 5.6%, with expectations that it will return to its target band by the second half of 2024.

HAWKISH SURPRISE

Markets and economists interpreted the central bank's commentary as hawkish.

The kiwi dollar shot up 0.8% to $0.6187, two-year swap rates rose 12 basis points to 5.205% and bank bill futures down as much as 7 ticks, reflecting expectations that more rate hikes were coming.

"The hawkish tilt comes despite recent data that on balance has gone the RBNZ’s way," said ANZ economists in a note.

It added this might be in part a strategy to prevent the market running away with the idea that cuts are imminent, given talk of easing in other parts of the world.

"But there does appear to be genuine concern that the bulk of the transmission of monetary policy is now in the rear-view mirror and core inflation and inflation expectations have not responded as hoped," ANZ said.

The RBNZ raised its forecast cash rate peak to 5.7%.

"Interest rates will need to remain at a restrictive level for a sustained period of time, so that consumer price inflation returns to target and to support maximum sustainable employment," the statement said.

New Zealand's decision comes a day after central bankers from the UK, Australia and Spain also flagged the need for monetary policy to remain restrictive for now to defeat rampant inflation.

That contrasts with far more dovish signals from the Federal Reserve, with investors now debating when the U.S. central bank might deliver its first rate cut and how soon others would follow suit.

The RBNZ was one of the first central banks to withdraw pandemic-era monetary stimulus and has lifted rates by 525 basis points since October 2021 to curb inflation. It is the most aggressive tightening since the cash rate was introduced in 1999.

The rate hikes have sharply slowed the economy but recent data showed it was tracking above central bank expectations.

(Reporting by Lucy Craymer. Editing by Sam Holmes.)