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Searing domestic inflation has the financial markets now picking a 75-point rise to the Official Cash Rate from the Reserve Bank next month and a peak OCR of over 5%


By David Hargreaves,

Latest inflation figures have provided a very nasty surprise, making wholesale interest rates leap and prompting forecasts of much bigger Reserve Bank interest rate hikes.

Significant mortgage rate rises are inevitable sooner rather than later.

Inflation has fallen very slightly to 7.2% for the year to September, down from the 32-year high of 7.3% hit in June.

But the result, which featured 2.2% inflation in the September quarter, is much higher than any market forecasts. And it very probably means the Reserve Bank will hit us with a 75 basis point rise to the Official Cash Rate (currently at 3.5%) in November. See Stats NZ media release here.

Wholesale interest rate markets boiled after the unpleasant inflation shock, with the two-year 'swap' rates for example surging by 19 basis points. A 75-point OCR rise next month is now about 85% priced-into rates while the markets now also pricing a better than 50-50 chance of ANOTHER 75 point rise in February.

At current wholesale market pricing, a peak OCR next year of around 5.3% is now being seen.

With wholesale rates at such levels, significant mortgage rate rises will already be being contemplated by the major banks. Expect these very soon.

After the inflation figures were released by Stats NZ on Tuesday, ASB economists were the first out of the blocks to officially pick a 75 point OCR rise next month - with two more 50 point rises early next year, giving a peak OCR of some 5.25%.

ANZ economists, who had previously had a market leading OCR peak pick of 4.75% for the middle of next year, also quickly changed their call, and now expect the RBNZ to hike the OCR by 75 points in both November and February before stopping to take stock.

"This takes the OCR to a peak of 5% by February (previously 4.75% by May). Both hikes are contingent on global financial markets keeping it together," ANZ economist Finn Robinson and chief economist Sharon Zollner said.

"Such large moves so late in the cycle are risky, no question, and could well turn out to be a mistake. But today’s data gives the RBNZ little choice. They are further behind the inflation game than thought."

BNZ head of research Stephen Toplis is also now picking a 75 pointer for November, but says this "may be the straw that well and truly breaks the camel’s back".

"We remain forecasting a 25 point hike at the [RBNZ's] February Monetary Policy Statement and we believe that the Bank [RBNZ] will use this Statement to explain why it has done enough. This should be relatively easy as it will be clear by then that the economy is headed into recession.

"Whatever the outcome we do not believe that current market pricing of a 5.4% terminal cash rate is sustainable. At rates approaching anywhere near that level the economy would be well and truly buried," Toplis said.

ASB senior economist Mark Smith said there is still "a large bow wave of inflationary pressure in place", with high rates of core and non-tradable (domestic) inflation still in evidence and the risk of these outcomes becoming increasingly entrenched.

"Inflation is much too high. Increasingly restrictive OCR settings are required," Smith said.

Kiwibank economists actually raised their forecast of the OCR likely peak twice during the morning, first from 4.0% to 4.50% and then to 5.0%. They also now expect a 75 point rise next month.

"Today’s report will be like a red rag to an inflation fighting bull. We have no choice but to expect a more aggressive RBNZ response. The CPI report was a shocker, to put it politely," Kiwibank chief economist Jarrod Kerr said.

The RBNZ had picked just 1.4% inflation for the quarter and an annual rate of 6.4%, although this pick was made back in August. Major bank economists with more recent economic data to go on had annual inflation picks in the 6.5% to 6.9% range.

So, the actual figures are a big shock.

The main culprit in the surprisingly high overall inflation numbers is domestically (IE in New Zealand) generated inflation, which hit an all-time high of 6.6%. That's a resounding shock and shows how hot inflationary pressures are within the country.

The 6.6% domestic inflation figure is the highest since Stats NZ started that data series in 2000.

As of June the figure had stood at 6.3%, so, the rise has been quite significant, as well as totally unexpected.

Stats NZ said construction of new dwellings, rentals for housing, and ready-to-eat food were the biggest contributors to the movement.

Imported, or so-called 'tradeable' inflation (things like oil prices) fell due to lower oil prices. Although, at 8.1%, down from 8.7% in June, it didn't fall anything like as much as expected.

Stats NZ said higher prices for petrol, vegetables, and international air transport were the biggest contributors to the tradeable movement.

But the big thing for us is the 'non-tradeable' figure, the domestically generated inflation.

That's trouble for interest rates.

The RBNZ has little control over imported inflation, but can try to rein in domestically generated inflation through hiking the Official Cash Rate. Already this year the OCR has been hiked by a record (for a calendar year) 275 basis points to 3.50%, with more to come in the final rate review for the year on November 23.

At its last rate review earlier in the month, the RBNZ pointedly mentioned that it had seriously considered raising the OCR by 75 points before finally deciding to raise it 50 points. Since those remarks were made market speculation had increased - even before the inflation figures came out - that the RBNZ will next time hike by 75 points.

Now a 75-pointer is seen as a racing certainty. The only real question is whether the RBNZ might even start to lean towards 100?

This story was originally published on and has been republished here with permission.