New Zealand's central bank on Wednesday hiked interest rates by a record amount and warned the economy might have to spend an entire year in recession to bring sky-high inflation under control.
The Reserve Bank of New Zealand (RBNZ) raised the official cash rate (OCR) by 75 basis points to 4.25 per cent and crucially now sees rates peaking at 5.5 per cent, compared with a previous forecast of 4.1 per cent.
The central bank's overtly hawkish tone caught some traders off-guard, lifting the local dollar and sending swap rates higher, while its predictions of a recession also surprised.
The RBNZ projects the economy will start contracting in the second quarter of 2023 and continue declining until the first-quarter of 2024.
"Inflation is no one's friend and in order to rid the country of inflation we need to reduce spending levels," RBNZ Governor Adrian Orr told a press conference. "That means that we will have a period of negative GDP growth."
Minutes from the meeting showed the RBNZ had even considered a full percentage point hike.
Markets were quick to price in a change in rate expectations.
Key two-year swap rates surge 27 basis points at 5.26 per cent. The market is now pricing in a cash rate peak of 5.54 per cent.
The kiwi dollar climbed 0.4 per cent to trade at $0.6164.
The RBNZ's ninth straight hike means the cash rate has now risen 400 basis points since October 2021 and is the most aggressive policy tightening since 1999 when the cash rate was introduced. It is now at a level not seen since January 2009.
"The RBNZ's stance was very hawkish, including discussing the potential for a 100bp hike," said ASB Bank in a note.
While 15 of 23 economists polled by Reuters had expected the central bank's policy committee to lift the cash rate by 75 basis points, the hawkishness of the bank's projections and language surprised.
ASB Bank added that the statement demonstrated a "clear urgency" but with three months until the next decision, the RBNZ would now watch the data flow to see if its level of hawkishness remained appropriate.
Inflation is currently at just below three-decade highs and non-tradeable inflation--or prices for goods that are not exposed to global markets--is running at a record. There are also signs wage pressures are heating up while inflation expectations have shown no signs of slowing.
ANZ noted the RBNZ was conducting monetary policy in a haze of uncertainty and continued to be open about that fact.
"In such an environment, it makes sense to look at the costs of being wrong in either direction and these simply aren't comparable," ANZ said.
If data does worsen significantly before the next meeting, it can adjust with little harm but if the opposite were to happen the RBNZ would have regretted not going harder, ANZ said.
House prices, which had been a significant inflationary factor in the tightening cycle are now down around 11 per cent, according to the central bank. The RBNZ expects prices will fall a total of 20 per cent from the November 2021 peak.