FX.co ★ RNBZ may raise interest rates by 75 basis points

The New Zealand dollar had a rather muted reaction to the news that the Reserve Bank of New Zealand is ready to raise interest rates by an unprecedented 75 basis points. The pair's rather large recovery since early October has stalled, but with news that the RBNZ is ready to accelerate monetary policy tightening to bring inflation under control, the bull market can be expected to continue in the medium term.

The Reserve Bank will reportedly raise the interest rate to 4.25 percent from 3.5 percent at its upcoming meeting. Fifteen of the 21 economists surveyed believe this will be the largest rate hike since the RBNZ introduced the OCR in 1999. The interest rate will be raised to its highest level since 2008.

The reason for this is higher-than-expected inflation and a near-record low unemployment rate, which is forcing the RBNZ to accelerate tightening after five consecutive 50-point hikes. This is similar to the path taken by the Federal Reserve, but stands in stark contrast to certain actions by other central banks, which are becoming more cautious about raising rates amid recessionary risks.

As noted above, recently released data clearly indicate that the Reserve Bank should take more aggressive action. Some economists anticipate a less aggressive approach and believe that the RBNZ will only go for a 50 percent increase because the market has not yet felt the full force of its 325-point tightening that could be seen since last October. Many households are still using fixed mortgage rates.

Investors are divided on which direction the RBNZ will go, with swaps pricing a 55% chance of a hike to 4.25%. After the policy decision this week, there is a three-month wait until the next meeting on February 22, which could also encourage the RBNZ to take a more aggressive stance.

The RBNZ will also release new forecasts in its quarterly Monetary Policy Statement, including a future track for the OCR. In its August outlook, the bank signaled that the OCR would rise to about 4% in early 2023 and that this would be enough to return inflation to its target band of 1-3% in 2024. However, at this point, annual inflation stood at 7.2% in the third quarter compared to the RBNZ's forecast of 6.4%. Inflation expectations have jumped to their highest level since 1991, fanning bets that an even higher peak will be required.

The OCR is expected to exceed 4.5% next year.

As stated earlier, New Zealand's strong labor market and strong economic recovery after Covid at the start of the year reinforce the need to keep raising borrowing costs. In the third quarter, the unemployment rate was 3.3%, just above the record low seen earlier in 2022, while wages rose the most on record.

On the technical side, NZD/USD bulls should concentrate on the resistance at 0.6200, a level which has been a problem for them recently. A breakout above this range will make it possible to test the highs at 0.6341 and 0.6465. The key target for bullish traders will be the May high of 0.6577. If the pair comes under pressure again, the level of 0.6020 will provide support. A breakout below this level will push the trading instrument to 0.5900 and 0.5780.