An Official Cash Rate hike that once looked unlikely to happen just 10 days before the election, is now the overwhelmingly expected outcome

A third consecutive Official Cash Rate (OCR) increase is being hotly tipped, with bank economists and financial markets expecting the Reserve Bank (RBNZ) to lift the OCR to 3% on Wednesday as it strives to combat inflation and a weak New Zealand dollar.

The RBNZ’s Monetary Policy Committee (MPC), which is in charge of setting the OCR, will have a long list of things to chew over at the October monetary policy meeting on October 28. It’s the second-to-last meeting this year, and the last one before the general election on November 7. The OCR is the RBNZ’s main tool for striving to keep inflation within its 1% to 3% target range.

Following the September MPC meeting, when the RBNZ raised the cash rate to 2.75% from 2.50%, RBNZ Governor Anna Breman hinted at a pause, and bank economists were divided on whether the RBNZ was likely to increase the OCR again on October 28.

“Future policy decisions will depend on the Committee’s judgement of the balance of risks to medium-term inflation,” the RBNZ said on September 2.

But almost two months on, the idea that the RBNZ might hold the OCR on Wednesday now appears unlikely. 

Bank economists at the country's biggest banks agree a 25 basis point hike is almost definitely going to happen as oil prices have surged, the NZ dollar has weakened further and inflation pressures remain unbearably sticky, creating a less-than-ideal environment for an inflation targeting central bank to hold fire. 

Oil shock & NZ dollar alarm bells

As of Friday, Brent crude oil was at US$112.50 a barrel, just US$2 off its early May peak, and the NZ dollar was below US60 cents and at AU81c.

BNZ’s head of research Stephen Toplis said BNZ is expecting a 25 basis point OCR increase, on top of the July and September hikes. The bank had “reluctantly” dropped this call straight after the RBNZ’s September OCR meeting, but has since resurrected the forecast in light of ongoing economic turbulence.

“The world is now in a very different place to what the RBNZ had anticipated and so it should adjust accordingly,” Toplis said.

He pointed to NZ’s refined oil prices, in the US dollar, being around 20% higher than the Reserve Bank would’ve been expecting back in September.

“This not only feeds straight into headline inflation but will maintain upward pressure on the prices of everything that is transported. Equally, it will continue to bolster inflation expectations,” he said.

However, Toplis believes higher oil prices are the RBNZ’s “least concern” because the impact from the weakness in the NZ dollar “rings alarm bells.”

“The currency is around 4% weaker than what the RBNZ had assumed. This must lift the Reserve Bank’s year ahead inflation forecast enough, by itself, to put at risk its ability to get inflation to the mid-point of its band,” he said.

Annual inflation, as measured by Statistics NZ’s Consumers Price Index (CPI), rose 3.7% in the September quarter. While this was a little lower than the RBNZ’s forecast of 3.9% and below June's 4.1%, underlying inflation pressures now have some economists expecting CPI inflation in the December quarter to come in as high as 4.7%.

“Taking all these things into consideration, we believe the Reserve Bank will not only need to raise its cash rate in October but should also signal there is more to come,” Toplis said.

Goldilocks-like levels

The rest of NZ’s major banks are also expecting a 25 basis point hike.

ANZ NZ chief economist Sharon Zollner agreed the significant shifts in oil prices and the exchange rate will “almost certainly” demand a response at the October MPC meeting, “but 3% is a slightly more comfortable fence to sit on.”

“The RBNZ makes up its own mind, but strategic factors matter too. If the RBNZ doesn’t hike, the NZ dollar is likely to come under more downward pressure, from its already sharply lower starting point. While the medium-term inflation outlook remains murky, it’s clear that would be unhelpful,” she said.

“We expect a relatively short statement that sounds open-minded about what comes next. We have pencilled in a pause in December at the slightly more comfortable perch of ‘neutral’, but we are also very open-minded. The data will dictate.”

ASB senior economist Mark Smith said a 25 basis point OCR increase was “roughly 90% priced in” by the market.

ASB currently expects back-to-back 25 basis point hikes at the RBNZ’s October and December meetings and has now priced in another 25 basis point hike at the February OCR meeting next year, bringing the cash rate to a peak of 3.50%.

“Higher for longer inflation is a major headache for the RBNZ as it risks pressuring inflation expectations and other nominal anchors higher. The upward revision reflects our updated assessment that the neutral OCR at an average of 3.5% is higher (~3.25% previously). This will mean more OCR tightening from here just to return settings to Goldilocks-like levels,” he said.

Kiwibank chief economist Jarrod Kerr said it was time for the RBNZ to “provide some certainty in a world plagued by uncertainty.”

“A rate hike next week could be delivered with a ‘wait and see’ commentary. Next week is a Monetary Policy Review (MPR), not a full Statement. So it’s light(er) on detail, without updated forecasts. A simple hike to then hold commentary would get businesses and households worrying less about rising interest rates,” Kerr said.

The dual mandate will be weighing on the RBNZ’s mind

Westpac NZ expects an OCR increase to 3% on Wednesday, and reach 3.5% by February. The bank has also priced in two more 25 basis point hikes at the RBNZ's June and September OCR meetings next year and sees it peaking at 4% by September 2027. 

The bank’s chief economist Kelly Eckhold noted that a committee vote, rather than consensus, seems “very possible” at the October meeting, with differences in view likely to remain across the RBNZ over how much the medium-term inflation outlook has really shifted in recent weeks.

“Beyond the pause that we had previously expected at next week’s meeting, we had expected the RBNZ would be looking to slow the pace of OCR increases once it had reached 3.5%. We retain the latter expectation, so this earlier hike also implies that the pause will come a little earlier, after two further 25 basis point hikes at the December 2026 and February 2027 reviews,” he said.

“Needless to say, the path of the OCR in 2027 will depend on the evolution of numerous factors that remain very uncertain, not least being developments in the Middle East.”

Eckhold said the RBNZ will be weighing up in the October meeting what happens if Labour wins the general election and restores the dual mandate, one of Labour’s election promises. NZ First leader Winston Peters is also in favour of returning an employment target to the Reserve Bank's monetary policy mandate.

The Labour-NZ First government introduced a dual mandate in 2018, when then-Finance Minister Grant Robertson added support for maximum sustainable employment, alongside the focus on inflation. The current Coalition Government removed the employment mandate in 2023. 

Eckhold said restoring the RBNZ's dual mandate will require the central bank's MPC to place greater weight on the labour market alongside inflation.

“As the degree of labour market slack currently seems high, a new mandate might justify the MPC taking more time to return inflation to the middle of the target range,” he said.

“This could figure into the deliberations of some MPC members if the decision between leaving the OCR unchanged and raising it now is viewed as finely balanced.”