RBNZ to reveal path for rate rises … here’s why we shouldn’t panic – Inside Economics

When it is released at 2pm, the full MPS with new forecasts and a new projected interest rate will give us a good steer on how the new governor and her team view the progress of the economic recovery and the inflation risk that might undermine it.

It’s expected the Reserve Bank (RBNZ) will move its forecasts for a rate hike from February to this December.

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There’ll be no shortage of concern about the prospects of higher OCR and what the timing will mean for mortgage rates.

But rates have to rise.

At 2.25%, the OCR is set at a stimulatory rate to give the economy a boost.

It isn’t supposed to stay this low, and we shouldn’t want it to.

Economists and central bankers talk about the “neutral rate”. That’s the rate where the OCR is neither stimulatory nor restrictive.

It’s a level it should sit when an economy is growing at its potential, without overheating and causing excessive inflation.

Ideally, the OCR should sit at the neutral rate for long periods of time while the economy chugs steadily along.

Unfortunately, it hasn’t been that way for several years now.

After the economic shock waves of Covid, New Zealanders have been on a rollercoaster of a monetary policy ride.

Rates were slashed to record lows to stimulate the economy through the pandemic. Then inflation hit and they were hiked to the highest levels we’d seen since the days before the Global Financial Crisis.

Then they were slashed again to the current stimulatory lows.

We’ve had six years of wild swings.

I’ll leave it to the upcoming independent inquiry to give us a verdict on whether the RBNZ could or should have charted a more stable path through this era.

The questions now are: what is New Zealand’s neutral rate? And when should we be back there?

Where’s neutral?

The Reserve Bank estimates the neutral rate is somewhere in the range of 3-3.5%.

In a recent research note Westpac chief economist Kelly Eckhold put it slightly higher, at 3.75%.

Either way, that is a lot further north than where we are now.

Whether it’s September or December or sooner or later than that, we should be under no illusions about the fact that the OCR will need to rise.

It seems to me that we’re all watching for signs of a possible rate hike as if they represented some impending doom.

That shouldn’t be the case.

If rates were to stay stuck at stimulatory levels for an extended period, it would be because the economic recovery had stalled.

The only reason rates would go lower from here is if something terrible happened to push us back into recession.

Nobody wants that.

So we should view rate rises as a natural part of the recovery story.

In today’s monetary policy statement, I’ll be looking for central bank confidence that the recovery is well and truly underway.

The timing of rate rises will remain speculative, but hopefully the direction of travel should be clear.

Crowded House

Q: In your recent article comparing the transtasman economies, you suggest that government spending by the Australian Government is “crowding out” the private sector.

While I understand the inflationary pressures of government spending when the economy is at capacity, I’m confused by the idea that the private sector is crowded out.

Surely the Government spends into the private sector. Even the highly paid public servant or consultant eventually buys a flash car or invests in the stock market.

Can you elaborate on how government spending (when the economy is at or near capacity) somehow constrains the private sector?

John O’Neill

A: Hi John, good question. The idea that public sector spending crowds out the private sector comes up a lot in economic commentary. But I’ve used it a bit casually without really explaining it. It’s also fair to say it’s not an uncontested idea.

As you note, if an economy is already at capacity, then yes, extra spending could put upward pressure on inflation simply by adding competition to the labour market.

A simple example might be: if the Government decides to embark on a programme of building state houses during a construction boom, then it just increases demand for builders and materials, pushing up prices for everyone.

Yes, that Government money is flowing through to the private sector but it is inflationary.

That’s why classic Keynesian economics would suggest that the Government should do its big spending when the rest of the economy is in recession and cut back spending when it is booming.

But there is another issue with the Government’s spending that runs a bit deeper when we look at borrowing and what that does to interest rates and capital flows.

When a Government is spending, it is usually also borrowing to do so, and by issuing bonds into the credit market, it is soaking up the demand for debt.

That pushes up interest rates and makes it harder for the private sector to borrow and invest.

Green shoots (and a few weeds)

The last week of data has seen some interesting releases for the Reserve Bank to chew over before signing off on its Monetary Policy Statement.

Business expansion

Both the Performance of Manufacturing (PMI) and the Performance of Services Indexes (PSI) have continued to show healthy levels of business expansion.

The seasonally adjusted PMI for January was 55.2 (a PMI reading above 50 indicates that manufacturing is generally expanding; below 50 that it is declining).

Although it was 0.9 points lower than December, it was still above the average of 52.5 since the survey began.

“The January PMI provides further evidence that the economy has finally turned the corner,” BNZ senior economist Doug Steel said.

“It is consistent with our forecasts and a breadth of indicators suggesting decent economic growth.”

The PSI also remained in expansion territory.

It was 50.9, although this was 0.8 points lower than December and below the average of 52.8 over the history of the survey.

“The big question to end 2025 was whether the economy may be turning,” Steel said.

“Data since then has given us confidence that recent positive momentum can be sustained. The economy is growing.”

Arrivals and departures

Net migration and tourism numbers released on Friday were also strong.

“Make no bones about it, today’s migration and tourism data are consistent with an economy that is starting to hum,” ASB senior economist Mark Smith said.

Migration data showed New Zealand citizen departures are now cooling, while non-resident arrivals are strengthening.

The provisional net migration gain was 14,200 in the year to December 2025.

That was up from 11,799 in the year to November.

Annual tourism arrivals lifted and were now back to 90% of their pre-Covid level, Stats NZ said.

Overseas visitor arrivals to New Zealand totalled 3.51 million in the December 2025 year, up 195,600 (6%) from the December 2024 year.

“The December 2025 year was the first annual period to exceed 3.5 million overseas visitor arrivals since the March 2020 year,” international travel spokesman Bryan Downes said.

Spending dip

Electronic card transaction data for January showed spending in the retail industries decreased 1.1%, or $78 million.

Spending in the core retail industries decreased 0.9% (or $60m), the Stats NZ data showed.

That’s clearly not what we wanted to see.

But ASB economist Kim Mundy suggested the wetter-than-usual weather may have had an impact on spending levels.

“We had expected a decline, given the severity of the weather that impacted multiple regions during the month,” Mundy said.

“Consumables and durables were also weak and extended declines in December,” she said.

“It’s likely that the weather impacted spending in these categories, too.”

Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003.

To sign up to his weekly newsletter, click on your user profile at nzherald.co.nz and select “My newsletters”. For a step-by-step guide, click here. If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.