Australia and New Zealand central banks chart divergent courses on interest rates


Central bankers are not usually known for their contrition, but sharp interest rate rises this year have forced policymakers in the Antipodes to defend their recent efforts to tamp down inflation.

In 2020, Philip Lowe, governor of the Reserve Bank of Australia, suggested he was unlikely to raise interest rates before 2024. But the RBA has enacted eight consecutive interest rate rises this year, leaving hundreds of thousands of mortgage holders facing much tougher repayments than anticipated.

“I’m sorry that people listened to what we’ve said and acted on that, and now find themselves in a position they don’t want to be in,” he told a senate hearing last week.

Lowe’s confession echoed comments across the Tasman Sea where Reserve Bank of New Zealand governor Adrian Orr told a parliamentary committee last month that more rate rises were needed to curb the “misery of inflation” after a record 0.75 basis point increase.

“We are sorry that New Zealanders are being buffered by significant shocks and inflation is above target,” Orr said. “As we’ve said before, inflation is no one’s friend and causes economic costs.”

Yet Australia and New Zealand have taken starkly different paths to combat inflation. While the RBNZ has adopted an ultra-hawkish stance to bring rising prices to heel at any costs, the RBA has sought out a “soft landing” in hopes of protecting its economy from additional shocks.

The Pacific neighbours are in a “tricky spot”, according to ANZ’s senior economist Catherine Birch, and face similar challenges: rampant consumer price index growth of about 7 per cent, tight labour markets, high levels of household debt and policymakers under pressure to cool economies that have boomed since pandemic border closures were lifted.

New Zealand started raising rates last year ahead of most of its global peers, with November’s increase bringing rates to 4.25 per cent. Its march against inflation and an overstimulated economy points to a policy that, according to ANZ, is deliberately trying to induce a recession.

Barclays said that the sharp rise reflected the central bank’s expectation that a “shallow recession” was necessary to subdue inflation. Birch said New Zealand had “out-hawked all expectations”, and forecast the interest rate would keep rising to 5.75 per cent next year.

The RBA, by contrast, remains more sanguine, despite having lifted interest rates 300 basis points in little more than six months, reaching a decade high of 3.1 per cent on Tuesday.

Lowe said that further rises were expected after the latest increase this week, but reiterated that the RBA had no “preset course” as it seeks to wrestle inflation down to its 2-3 per cent target range. The central bank is widely expected to slow the pace of its tightening in 2023.

Gareth Aird, head of Australian economics at Commonwealth Bank, said the RBA has bought itself flexibility to react as inflation data emerges, and forecast rates to peak at the bank’s next meeting in February with another 25 basis point increase. “The path towards achieving a soft landing for the economy gets narrower with each additional rate increase,” he said.

Australia’s need for a soft landing reflects its high levels of household debt — which stands at 123 per cent of gross domestic product, among the highest in the developed world — which makes the country more vulnerable to interest rate rises than in New Zealand, where the figure is close to 100 per cent.

Wage growth is another significant factor. New Zealand’s wage growth has been stronger than Australia’s, where inward migration has bounced back following labour shortages driven by coronavirus restrictions, raising the risk of a feedback cycle between rising inflation and wages.

Shane Oliver, chief economist at AMP, pointed to the central banks’ divergent approaches in recent years. “The RBA seems to take a more patient approach to getting inflation back down under its inflation targeting framework than the RBNZ does,” he said.

“The RBNZ [has been] a lot more erratic over time than the RBA is — it got more dovish before and through the pandemic, whereas the RBA likes to keep things on an ‘even keel’.”

Neither path comes without risk, as both the RBA and RBNZ work to re-establish their reputations. Both countries are sensitive to declining house prices, and with mortgage stress likely to grow as the impact of interest rate rises weighs on household budgets, the central banks’ strategies will come under ever-greater scrutiny.

Birch said the RBA could find inflation proves to be more persistent than it has forecast, forcing it to pursue more aggressive rate rises that might damage the economy in 2023 when it could have “gone harder earlier.”

Meanwhile, the success or failure of the RBNZ’s ultra-hawkish strategy will not become clear for some time, during which it risks overcorrection. “The RBNZ is ‘driving while looking in the rear-vision mirror’ and risks missing the turn,” she said.