Strong inflation and growth point to more RBNZ tightening, BNZ warns

With markets already pricing in a 94% probability of a rate increase, the September decision carries little potential for surprise. The focus shifts to how the RBNZ will frame the path beyond. BNZ's forecast for September-quarter inflation at 3.7% is well above the RBNZ's own July projection of 3.3%, pointing to a widening gap that could push the central bank into more aggressive guidance than markets currently anticipate. The key pricing question is whether both October and December meetings carry live hike risk, while futures currently reflect only one additional move across those two meetings.

BNZ describes a hike at the September 2 meeting as virtually locked in, but believes the RBNZ will eventually need to tighten further and faster than its own current guidance suggests.

Key points:

• BNZ expects the RBNZ to lift the cash rate by 25bp to 2.75% at the upcoming September MPS, calling it near certain given 94% market pricing.
• The RBNZ is seen signalling further tightening toward a peak around 3.5%, though BNZ's own house view sees the cash rate reaching 4.0% by May 2027.
• BNZ forecasts September-quarter annual CPI at 3.7%, above the RBNZ's July estimate of 3.3%, with growth also tracking at least as strong as expected.
• Downside risks include a potential El Nino-driven recession, election-related delays to the recovery, and a broader global asset price correction; upside risks centre on structural inflation and weaker output growth.
• A softer unemployment rate is unlikely to deter the RBNZ, as employment and wages both run a touch stronger than anticipated; Q2 retail sales slowed to 3.3% annual growth, weighed by a 13.1% drop in fuel volumes.

BNZ anticipates the RBNZ raising the official cash rate by 25 basis points to 2.75% at its September Monetary Policy Statement, describing the move as effectively a done deal given markets are already pricing a 94% probability. The central bank is expected to signal further increases until the cash rate reaches or exceeds neutral, with a published peak near 3.5%. However, BNZ's own projection is for the cash rate to rise by 25bp at every meeting until hitting 4.0% by May 2027.

BNZ flagged risks in both directions, though it judges downside risks as somewhat more prominent. These include a potential El Nino-driven recession, election-related delays to the recovery, and a broader global asset price correction. On the upside, it pointed to the possibility that structural inflationary pressures continue building regardless of central bank responses.

Central to BNZ's view is the RBNZ's July language that further reduction in monetary stimulus was likely required to return inflation to target. BNZ expects inflation to remain above the target band until mid-2027, forecasting 3.7% annual CPI for the September quarter, well above the RBNZ's own 3.3% projection, with growth also tracking at least as strong as expected. Oil prices, while below their peak, have risen 12% since immediately before the RBNZ's July commentary, eroding some of the disinflationary comfort the central bank had drawn on.

On the labour market, BNZ said the only plausible reason for the RBNZ to pause would be higher unemployment, but with employment and wage growth both a touch stronger than expected, it sees this as insufficient cause for hesitation. BNZ expects Friday's data to show a 0.4% lift in Q3 employment, an 11-quarter high, enough to halt the rise in unemployment. Q2 retail sales fell 0.5% quarter-on-quarter, slowing annual growth to 3.3%, though core ex-auto sales still rose a solid 0.7%, with BNZ expecting some bounce back in the September quarter as fuel costs retreat further.