Central banks’ reaction functions diverge

Central banks in Australia and New Zealand have taken starkly different approaches to managing the inflation-unemployment trade-off in their countries. Despite being behind the curve on interest-rate hikes relative to other advanced economy central banks, the RBA decided to hit pause at its April meeting. As RBA Governor Lowe later explained, the Board was willing to allow inflation to return to its 2-3% target range at a slower pace if it could preserve the country’s pandemic-era job gains in the process. By contrast, the RBNZ surprised markets last week with an outsized 50bp rate hike, sending the message that it remains determined to break the back of inflation at any cost. Indeed, the RBNZ largely shrugged off the New Zealand economy’s underperformance in Q4, as well as concerns over the potential fallout from recent adverse weather events. Reflecting in part these contrasting policy choices, we believe that the Australian economy is headed towards a soft landing this year, while New Zealand faces the prospect of a deep economic contraction.