Reserve Bank expected to lift OCR to 2 percent

The Reserve Bank is set to raise its benchmark interest rate to its highest level in six years as it rejoins the battle with surging inflation.

The central bank is expected to lift the official cash rate (OCR) by 50 basis points (half a percentage point) to 2 percent tomorrow in the latest monetary policy statement, with a warning that further rises are coming.

The increase closely follows a similar sized rise in April, when the RBNZ said it was taking a "stitch in time" approach to tackling inflation at a 30-year high of 6.9 percent.

ASB Bank economist Mike Jones said the RBNZ could afford to give "no quarter" to inflation and the need to get it under control as soon as possible.

"The path of 'least regret' for the Bank is still to get the OCR to a neutral setting - about 2 percent - quick smart, then adopt a more cautious stance from there," Jones said.

The "neutral setting" is regarded as the level at which the OCR is neither over stimulating the economy nor suppressing growth, although the cash rate is expected to hit at least 3 percent in the short term as the RBNZ tackles the current spike.

The RBNZ has two overriding mandates from the government: to keep inflation settled around 2 percent and ensure maximum sustainable employment.

It has clearly failed with the first at the moment, and overachieved with the second, given unemployment is at a record low 3.2 percent.

Wage price spiral fears

One of the bank's major fears is that the tight labour market will stoke wage pressures, which in turn will fuel prices.

Domestic inflation such as wages, food, rents, and over-exuberant consumer spending are more directly controlled by rises in the OCR, while imported inflation such as fuel, fertiliser, and the higher prices caused by supply chain disruptions and the Ukraine war are out of the RBNZ's control.

In April the monetary policy committee, which sets the OCR, said it would "remain focused on ensuring that current high consumer price inflation does not become embedded into longer-term inflation expectations."

That means a series of rate rises for the rest of the year, although the RBNZ is expected to be more mindful of the size of future rate rises.

Kiwibank chief economist Jarrod Kerr said the RBNZ would need to have an aggressive tone to its statement to manage inflation expectations, while trying to engineer a soft economic landing by not going too far with rate rises.

"It's easy to say that the risk of a recession rises with every rate hike. Recession risk is why we expect the RBNZ to pause at 3 percent, and not follow through with its forecast tightening in entirety."

Nonetheless, retail interest rates are set to rise as a result of any OCR rise, biting into households budgets and slowing consumer spending.

The head of mortgage broker Squirrel, John Bolton, said shorter-term mortgage and other rates would rise on an RBNZ increase.

"I think they have got a bit of room to go up but I certainly feel that we are not far off peak at the moment with some of those longer-term fixed rates. But notwithstanding people are coming off very low rates so they are going to experience a significant increase in repayments."

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