(Bloomberg) -- New Zealand’s central bank kept interest rates unchanged for a seventh straight meeting and signaled policy will need to stay tight for longer to stamp out stubborn inflation. 

The Reserve Bank’s Monetary Policy Committee held the Official Cash Rate at 5.5% on Wednesday in Wellington, as anticipated. The bank’s new forecasts show reductions starting in the third quarter of 2025 instead of the second.

“The Committee discussed the possibility of increasing the OCR at this meeting,” the RBNZ said. While it is confident inflation will decline over the medium term, “the Committee also agreed that interest rates may have to remain at a restrictive level for longer than anticipated” in February, it said.

The RBNZ is finding it harder than expected to get inflation back to the target, even though New Zealand’s economy has been in recession and the labor market is slackening. While investors are still betting the RBNZ will start cutting rates later this year, several leading economists don’t see it pivoting to easing until the first or second quarter of next year.

“The statement was hawkish compared to expectations,” said Nick Tuffley, chief economist at ASB Bank in Auckland. “We have retained our view that the RBNZ will start cutting the OCR from February 2025, but the risk is later.”

The New Zealand dollar surged almost 1% after the decision before paring its gain to trade 0.4% higher on the day at 61.19 US cents. Policy sensitive two-year government yields climbed seven basis points to 4.77%, paring an earlier rise of as much as nine basis points.

Money markets trimmed expectations of rate cuts this year to price 34 basis points of easing by year-end, according to swaps data compiled by Bloomberg. Prior to the meeting, traders had priced 45 basis points of rate cuts.

The RBNZ’s updated forecasts show the average OCR peaking at 5.65% this year compared to 5.60% in its previous projections in February. That implies a 60% risk of a hike. The projections show the average OCR falling to 5.4% in the third quarter next year.

‘Real Consideration’

RBNZ Governor Adrian Orr told reporters that a rate hike was a “real consideration” at this meeting, and the Committee has limited tolerance for upside inflation surprises. At the same time, it was confident inflation would return to target over the medium term.

“Monetary policy is unambiguously restrictive, the economy is unambiguously very low in terms of economic activity and the output gap is growing, so we know we are going to get there,” Orr said.

Policymakers globally have had to keep rates higher for longer amid stubbornly persistent price pressures.

Australia’s central bank resumed a discussion about rate hikes at its May meeting before deciding to stand pat, while Federal Reserve officials have signaled they’re likely to ease less this year than earlier expected. 

While weaker capacity pressures and rising unemployment in New Zealand are reducing inflation, the decline is being tempered by price increases in sectors of the economy that are less sensitive to interest rates, the RBNZ said. These include higher rents, insurance costs and local government rates.

Inflation eased to 4% in the first quarter, the weakest reading in almost three years, but a gauge of domestically generated inflation barely slowed to 5.8%.

The persistence of domestic inflation “remains a significant upside risk,” the RBNZ said.

What Bloomberg Economics Says...

“Despite its hawkish tone, we don’t think the RBNZ will hold rates at current levels for as long as it projects. A combination of persistently weak domestic data, softer-than-projected inflation and rate cuts from the US Federal Reserve is likely to prompt the RBNZ to cut rates late in 2H24.” 

— James McIntyre, economist

To read the full note, click here

The central bank on Wednesday forecast inflation will drop back into its 1-3% target band in the fourth quarter this year, three months later than it previously expected. It doesn’t see it returning to its 2% goal until mid-2026 — six months later than projected in February.

“Monetary policy may need to tighten and/or remain restrictive for longer if wage and price setters do not align with weaker productivity growth rates,” the Committee said in its record of meeting.

The economy contracted in the second half of last year and latest data suggest it will remain moribund this year. The RBNZ’s forecasts show modest growth through 2024.

Soft economic data “suggests progress on getting domestic inflation down is about to accelerate meaningfully,” said Sharon Zollner, chief New Zealand economist at ANZ Bank in Auckland. “However, the RBNZ is going to believe that when it sees it.”

--With assistance from Matthew Burgess.

(Updates with economist’s comments.)

©2024 Bloomberg L.P.