Just announced: Reserve Bank of New Zealand raises rates by 25 basis points for the first time in more than two years! A return to normal, rather than full-scale tightening?

This afternoon, the Reserve Bank of New Zealand (RBNZ) announced an increase in the Official Cash Rate (OCR) of 25 basis points to 2.50%. This is its first rate rise since May 2023, and the first under new Governor Anna Breman.

For financial markets, the outcome was hardly a surprise. Before the announcement, markets had already priced in roughly a seventy per cent chance of a rate rise, and several banks and economic institutions also considered the move highly likely.

However, what really matters about this decision is not the 25 basis points themselves, but a more significant policy signal from the Reserve Bank: the accommodative monetary policy in place for more than a year is starting to be withdrawn gradually, as New Zealand enters a new phase of monetary policy normalisation.

Why raise rates when oil prices have fallen?

Over recent weeks, easing tensions in the Middle East and the resumption of some oil tanker traffic through the Strait of Hormuz have brought a marked decline in international oil prices, easing market concerns about inflation.

The Reserve Bank of New Zealand now forecasts annual inflation to peak at around 3.9% in the second quarter of this year, below the 4.3% forecast in May. It expects inflation to fall further to 3.3% in the third quarter. In the short term, inflationary pressure has indeed eased.

This is precisely why many people may ask: if inflation is falling, why has the Reserve Bank still chosen to raise rates?

The answer lies in the policy statement the Reserve Bank released that day.

The Reserve Bank made clear that although falling international oil prices have eased near-term inflationary pressure, the effects of the energy price shock will persist for some time, and considerable uncertainty remains around the medium-term inflation outlook. Monetary policy looks beyond today's oil prices to price trends over the next one to two years.

In other words, this rate rise is intended not to address inflation that has already occurred, but to prevent inflation from moving away from target again as the economy recovers and demand picks up.

Finance Minister: “Easing off the accelerator a little”

Following the meeting, Finance Minister Nicola Willis described the rate rise as more like “easing your foot off the accelerator a little” than slamming on the brakes.

The analogy neatly captures the Reserve Bank's current policy approach.

For more than a year, New Zealand has maintained relatively accommodative monetary policy to support the economic recovery, providing lower borrowing costs for businesses and households. Now, with international oil prices falling and the economy gradually recovering, the Reserve Bank believes it can moderately reduce the stimulus supporting the economy.

Notably, the Reserve Bank expects New Zealand's economy to return to growth in the third quarter after a brief slowdown in the second, with GDP growth currently forecast at around 0.6%. Consumer confidence and some business activity indicators have also begun to improve.

The rate rise therefore looks more like a precautionary adjustment. The Reserve Bank wants to gradually return policy to normal levels before the economy overheats, rather than wait for inflation to pick up again and then impose more aggressive tightening.

Reserve Bank: a 2.50% interest rate is still “accommodative”

One sentence in this policy statement deserves particular attention:

The current level of the OCR remains stimulatory (“The current level of the OCR remains accommodative”).

This means that although the Official Cash Rate has risen to 2.50%, the Reserve Bank considers the current interest rate to be supporting the economy rather than restraining it.

Many people hear “rate rise” and assume that monetary policy is entering full-scale tightening. From the Reserve Bank's perspective, however, it is only beginning to gradually reduce stimulus and has not entered a tightening cycle in the true sense.

The Reserve Bank also noted that New Zealand's neutral interest rate is currently around 3%. The neutral interest rate is the level that neither stimulates the economy nor restrains economic growth.

Even after this rate rise, New Zealand's monetary policy remains on the accommodative side, with some distance still to go before it truly returns to neutral.

This is also why the Reserve Bank explicitly stated that further reductions in monetary stimulus may still be needed to ensure inflation ultimately returns to the 2% target midpoint.

Oil prices are not the Reserve Bank's real concern

Many people believe the current bout of inflation stems mainly from international oil prices.

But the meeting minutes released by the Reserve Bank show that its real concern is businesses' future price-setting behaviour.

The Reserve Bank believes that if businesses broadly choose to raise prices when costs increase, then lift profit margins further as demand recovers, their continued price increases could keep inflation elevated even if oil prices fall.

On the other hand, some spare capacity remains in New Zealand's economy. Intense market competition may prevent many businesses from passing all their costs on to consumers, forcing them to absorb some themselves. This is one reason the Reserve Bank sees continued uncertainty around medium-term inflation.

The Reserve Bank also warned that continued weakness in the New Zealand dollar could raise the prices of imported goods, potentially pushing inflation up again in future.

Why was the market reaction so muted?

Although this was the first rate rise in more than two years, financial markets remained relatively calm overall.

This was because markets had already largely priced in a rate rise. Following the announcement, the New Zealand dollar rose only slightly, while bond market movements were limited.

The Reserve Bank also noted that financial conditions had actually eased recently, with market interest rates falling and the New Zealand dollar weakening. Keeping the OCR unchanged could have led to further easing. Avoiding excessively loose financial conditions was therefore another consideration behind this rate rise.

Finance Minister Nicola Willis also said that because banks had already adjusted some lending rates in line with market expectations, the OCR increase was not expected to cause an immediate sharp rise in mortgage rates.

Will there be further rate rises?

This is the question markets care about most. The Reserve Bank's answer is: possibly, but the timing is uncertain.

The policy statement noted that further reductions in monetary stimulus are likely as the economy gradually recovers and inflation remains above the target range.

However, the Reserve Bank also stressed that every future OCR decision will depend on the latest economic data, including inflation trends, business price-setting behaviour, the labour market, consumer demand and global economic conditions. It will not mechanically raise rates according to a predetermined roadmap.

This means the market's focus is gradually shifting from “will rates rise?” to “when will they rise again, and how high will they ultimately go?”

A return to normal, rather than full-scale tightening

On the surface, this is simply an interest rate adjustment of 25 basis points. At a deeper level, however, it marks New Zealand's gradual shift from monetary policy focused on stimulating the economy towards a more balanced, normal setting.

Falling international oil prices have given the Reserve Bank greater policy room, while renewed economic growth has strengthened its confidence in gradually withdrawing accommodative policy.

For ordinary households, this rate rise may not immediately increase mortgage costs. But as the Official Cash Rate continues moving towards neutral, overall borrowing costs could still rise slowly. For savers, deposit rates are expected to remain relatively high.

What matters most is not that the OCR rose by 25 basis points today, but that the Reserve Bank of New Zealand has formally taken the first step towards normalising monetary policy. Future interest rate movements will depend more on whether inflation continues to fall and whether the economic recovery gains a firm footing.