Will the pioneering central banks raising interest rates be proved right?

Central banks raising interest rates inflation 2021 reserve bank
New Zealand’s Reserve Bank has upped interest rates to combat emerging inflation.

Which central banks are making mistakes and which ones are reading the global situation correctly?

It is an open question at the moment with some pioneering central banks already raising interest rates to fight emerging inflation while most others sit on their hands and at best begin to taper bond purchases.

The Reserve Bank of New Zealand (RBNZ) is one of those few pioneers after last week raising interest rates for the first time in seven years as it also signalled more rate increases to come as it tries to get on top of inflationary pressures and cool down a hot housing market.

By raising its official reference rate by 0.25% to 0.5%, the RBNZ decided the risks of the ongoing COVID-19 outbreak in Auckland was not enough to delay raising rates any longer.

Exclusive group of rate risers

The rate hike puts New Zealand in fairly exclusive company with Norway, the Czech Republic and South Korea among a select few who have already raised interest rates.

Most other central banks are being very careful about winding back stimulus measures, although in the US and Australia there is some tapering of bond purchases going on.

While rates in those countries still show no sign of being jacked up off the floor, such tapering is at least a warning that the time to raise rates in getting closer, even if the central bankers involved put that period in terms of years rather than months.

Bank hit pause and reduced rise due to COVID-19 outbreak

Even the RBNZ had hesitated for a while due to the impact of the Auckland COVID-19 outbreak, but once the country had acclimatised to the fact that a COVID exclusion policy needed to be replaced by one of vaccination and living with the virus, then the decision was made.

It should be noted though that its original idea of raising rates by 0.5% was cut in half due to continuing uncertainty, although the bank pointed out that capacity constraints were more of an issue than a lack of demand.

More rises where that came from

RBNZ went further too, saying that further removal of monetary policy stimulus was expected, with future moves depending on the medium-term outlook for inflation and employment.

New Zealand has enjoyed a fast economic recovery since last year’s recession, but with its borders still shut, labour and goods shortages are pushing up inflation, as well as contributing to a surging property market driven much higher by ultra-low interest rates.

While the RBNZ expects inflation to peak above 4% before falling back to around 2% later, raising rates at least starts it on the path to normalising monetary policy and gives the bank more flexibility in pushing inflation down should it start to veer on the upside.

It is the exact opposite of the US and Australian approach of keeping rate ultra-low and to deal with emerging issues such as property price rises with measures other than higher interest rates.

Eventually, though, official interest rates will need to rise and perhaps sharply should inflation surprise on the upside and prove to be a much more permanent fixture and less of a “transitory effect.’’

It remains to be seen whether the early moving central banks are on the right track and are followed by others or whether they have switched direction too early.

The stakes are high, with those central banks making the right decision able to have a lot more flexibility in dealing with any unforeseen pressures than those that end up behind the curve and reacting through necessity.

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