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Rapid pace of interest rate cuts seen stimulating activity

The Reserve Bank of New Zealand (RBNZ)’s decision to cut the Official Cash Rate (OCR) by an additional 50 basis points (bps) to 3.75% in its Monetary Policy Statement (MPS) on 19 February had very little impact on market pricing as the bond market had already priced in further monetary easing. As a result, we feel that the OCR’s projected path to the 3% level, which we consider likely to be the lowest point of the current cutting cycle, may be more noteworthy than the reduction itself. Specifically, the MPS showed that the RBNZ has brought this point forward in its projections, effectively to the third quarter of 2025. The RBNZ started the current cycle of cuts in August 2024 with a reduction of 25 bps from 5.5% to 5.25%. Therefore, if the OCR reaches 3% by the third quarter of 2025, the RBNZ will have reduced interest rates by 250 bps over the course of approximately a year. We expect the easing cycle to sufficiently stimulate economic activity if it progresses at such a speed.

Length of time at lowest point of cycle seen as increasingly significant

Although the RBNZ’s projection also shows the OCR staying at the 3% level until 2028, we do not expect interest rates to remain at the bottom of the cutting cycle for such a long period. In our view, once the OCR has fallen to that level, past precedent suggests that a new tightening cycle or a change in the direction of interest rates is likely to follow approximately nine to 12 months afterwards. As a result, a key question for us is the length of time the OCR is likely to stay at the end point of the current easing cycle. One reason for the significance of the 3% figure is that it represents the midpoint of the 2.5% to 3.5% range, which the RBNZ currently deems to be the “neutral” level at which interest rates are neither inflationary nor deflationary for the economy. This suggests that having the OCR at that level would give the RBNZ flexibility to hike or reduce rates depending on the extent to which previous cuts have stimulated the economy.

US tariffs likely to be inflationary in short term but deflationary further on

On a global level, the possibility of additional tariffs by the Trump administration in the US is attracting significant attention. The key question from a bond market perspective is whether the tariffs will be inflationary or if they will have a cooling effect and, by extension, whether they will lead to a monetary policy response. In New Zealand’s case, we feel it is unlikely that the tariffs will cause the OCR to deviate from its path towards 3%. However, we expect the RBNZ to monitor the tariff situation closely given the likelihood of increased volatility in New Zealand’s consumers price index. Overall, we view the tariffs as inflationary in the short term but deflationary over the medium term.