‘Principal economic challenge’: Treasury’s inflation outlook spurs interest rate lift

New Zealand wholesale interest rates bumped up by five basis points across the yield curve after the Treasury’s inflation forecasts came in much higher than the market’s, and the Reserve Bank’s.

The Treasury, in its Budget update, forecast inflation at 6.7 per cent for 2022, 5.2 per cent for 2023 and 3.6 per cent for 2024 (June years).

Westpac’s forecast is also 6.7 per cent for 2023 but is much lower in the years beyond — 2.9 per cent for 2023 and 2.7 per cent for 2024.

The Reserve Bank’s forecast, published in February, is lower still — 6.3 per cent for 2022, 2.6 per cent for 2023 and 2.3 per cent for 2024.

The New Zealand dollar was largely unchanged at US63c after the Budget, but swap rates lifted.

The two-year swap rate went to 3.58 per cent from 3.53 while the 10-year swap rose to 3.8 per cent from 3.75.

Westpac senior markets strategist Imre Speizer said the lift in swap rates was most likely in reaction to the inflation forecasts.

“At face value, the Treasury forecasts would mean a much higher official cash rate (OCR),” he said.

“It was a knee-jerk reaction, but of course they are only forecasts, and the Treasury does not determine the OCR.”

The Reserve Bank next week is expected to increase its OCR by half a point to 2 per cent. More rate hikes are expected later in the year.

The Treasury said inflation had surfaced as the “principal economic challenge” in New Zealand and abroad.

“Consumers Price Index (CPI) inflation — which reached a 30-year high of 6.9 per cent in the March 2022 quarter — is being driven by strong domestic demand pushing up against constrained supply, which in turn has been compounded by the Russian invasion of Ukraine,” it said.

In response, the Reserve Bank of New Zealand has signalled its intention to tighten monetary policy at pace, which will act as a constraint on economic activity, the Treasury said.

“This has had an immediate impact on house prices that are forecast to fall throughout 2022 and 2023,” the Treasury said.

As expected, the Budget contained an enlarged bond tender programme — mostly reflecting the refinancing of the Reserve Bank’s bond buying activities employed under its largescale asset purchase programme (LSAP), which was aimed at keeping interest rates low during the Coviddriven economic downturn.

The 2022/23 programme has been set at $25 billion, $7b higher than that published at December’s fiscal update. The forecast programmes for 2023/24 and 2024/25 have also been increased by $7b each year, to $25b, while the 2025/26 programme

will increase by $5b to $15b.

Rating agency S&P Global said it expects New Zealand’s fiscal outcomes to be stronger than indicated in the Budget, mainly because of reporting differences.

“Unlike many sovereigns, New Zealand’s fiscal accounts include transactions of the central bank, the Reserve Bank such as the $22b funding-for-lending programme.

“We exclude these flows from both revenues and expenses as they are for monetary policy purposes,” the agency said.

S&P Gobal said New Zealand’s economic recovery continues, even as inflation and capacity constraints start to bite.

The agency said the Budget’s economic update indicates an improving fiscal outlook, albeit slower than S&P’s previous forecast, due to rising economic headwinds.

“The stable outlook on our ratings on New Zealand is supported by our expectation that there is enough headroom within the current rating to address potential risks,” it said.

S&P Global still expects the Government’s books to show a return to surplus in 2025.