RBNZ holds rate at 2.25% in split vote, hikes expected this year

New Zealand's central bank narrowly avoided a rate increase as three external members pushed for a quarter-point hike, exposing deep divisions over how to manage inflation that has breached its target band.

The Reserve Bank of New Zealand held its official cash rate at 2.25% by the narrowest possible margin Wednesday, with Governor Anna Breman casting the deciding vote against three external members who sought a 25-basis-point increase to 2.50%.

"The Committee remains focused on bringing medium-term inflation back to target and expect that OCR increases will be required this year," the RBNZ said in its statement.

The 3-3 vote split marks the first time the central bank has published dissenting views attributed to individual members, a transparency measure adopted this year. The three internal members — including Breman — voted to hold, while all three external appointees voted to raise rates.

New Zealand's economy remains fragile after one of the most aggressive tightening cycles among developed nations, with unemployment at 5.3% and annual GDP growth revised down to 0.9%. Yet first-quarter inflation of 3.1% has already breached the central bank's 1%-3% target band, and the RBNZ now expects consumer prices to peak at 4.3% in the September quarter — a level that all but guarantees rate increases before year-end.

Rate Differentials Widen as Global Peers Tighten

The RBNZ's reluctance to act contrasts with its closest peer. Australia's central bank has already raised rates three times this year after inflation proved more persistent than expected, widening the policy rate differential between the two trans-Tasman economies. New Zealand's exposure to the Middle East conflict — as a net importer of fuels such as gasoline and diesel — has compounded the inflation challenge, with oil prices above $100 per barrel for most of the past two-and-a-half months since the conflict began.

The last time the RBNZ faced a similar inflation overshoot was in 2022-2023, when it raised the OCR by 525 basis points in one of the steepest tightening cycles in the developed world. That cycle eventually pushed the economy into a prolonged downturn from which it is only now showing signs of emerging, the central bank said.

The hawkish hold is likely to support the New Zealand dollar, which has been under pressure as the RBNZ lagged its peers. A stronger NZD would help contain imported inflation by reducing the cost of fuel and other goods priced in foreign currency, potentially giving policymakers more room to delay rate increases.

Markets Price Two Quarter-Point Hikes by Year-End

Economists surveyed by Reuters are divided on timing but increasingly convinced that rates will rise. Just over half of 29 respondents — nearly 52% — forecast one or two rate increases by the end of the third quarter, a sharp shift from April when only eight of 30 economists expected a move by end-September. Poll medians show the RBNZ raising rates 50 basis points in total to 2.75% by the fourth quarter, with a final increase to 3.00% by the end of the first quarter of 2027.

"Our expectation is the Reserve Bank will start lifting interest rates from July, given the risks to the inflation outlook have gotten very skewed to the upside," said Nick Tuffley, chief economist at ASB Bank.

Major New Zealand banks are split on the magnitude of the coming cycle. ASB and BNZ forecast 100 basis points of tightening by March 2027, while ANZ predicts 75 basis points and Westpac sees a steeper 125 basis points. Kiwibank expects just one rate increase over the same period.

The central bank's own projections show inflation not returning to the midpoint of its target band until mid-2027, suggesting the tightening cycle, when it begins, will be protracted. Higher fuel prices are increasing costs, lowering profit margins for many businesses, and reducing real incomes and household purchasing power, the RBNZ said.

"What they will be worrying about is inflation expectations lifting and remaining high and inflation starting to move beyond fuel pump prices and transport costs," Tuffley said. "If we start seeing inflation spreading into the service sector or wages, that's much more worrying."

High-frequency data, including electronic card transactions and measures of business and consumer confidence, point to weak demand in the near term, the central bank added, showing the delicate balance policymakers face between containing inflation and supporting growth.

This article is for informational purposes only and does not constitute investment advice.