RBNZ hold shakes faith in central bank rate forecasts

The central bank bonanza got underway with a significant jolt today. While the Federal Reserve has dominated market conversations all week, the Reserve Bank of New Zealand jolted traders earlier today with a reminder that nothing should be taken as guaranteed. Despite traders assigning roughly a 90% probability to a 25 bps rate hike, the central bank instead kept rates unchanged at 2.75% in a tight 4-3 decision.

The market fallout from the surprise is reflected in the kiwi, with NZD/USD dropping 1.3% to 0.5605 today. But the question remains whether a wider takeaway exists beyond what has already been observed.

For much of the past decade, traders have become accustomed to central banks offering extensive forward guidance and hand-holding through major policy choices. Central bankers would typically flag their next move well ahead of time, offering traders a reasonably clear pathway to follow in the run-up to the forthcoming meeting.

Now, that sort of luxury appears to be gradually fading away.

The core issue is that central banks are currently managing a very tricky balancing act. Inflationary pressures remain persistent while higher borrowing costs and growing fiscal burdens are weighing on growth conditions, making it difficult for central banks to lock into a specific policy direction.

Looking at the RBNZ today, policymakers were not convinced that another rate hike was warranted just yet even with inflation at 3.7% and forecast to reach 4.4% in the fourth quarter of the year. That stands as a telling assessment of the current environment confronting major central banks.

Although inflation remains the primary challenge to be tackled, the threats to growth and the necessity of assessing earlier tightening moves were enough to push the balance toward holding steady in the RBNZ's case.

So, should we anticipate similar shocks from the Fed or ECB this week?

Not necessarily, I would argue. All things being equal, I would avoid overreacting to a single decision from a major central bank. After all, the RBNZ has a history of springing surprises from time to time.

For the Fed, they are widely anticipated to hold interest rates steady today. Meanwhile, the ECB is strongly expected to remain on the sidelines tomorrow. Those remain fairly sensible baseline assumptions for the respective central banks.

In my opinion, the RBNZ surprise is less about forecasting the next central bank shock and more about how markets ought to approach policy expectations going forward.

Now, the Fed must weigh persistent inflation against the danger of tighter financial conditions. As for the ECB, they also have to grapple with rising borrowing costs and fiscal worries across Europe.

While the decisions this week are likely to unfold as markets expect, what happens thereafter remains open to interpretation. As things stand, no central bank wants to commit to a rate hike today only to discover that growth conditions have deteriorated sharply a few weeks later.

Whatever happens, the Fed and ECB are major institutions that generally avoid upsetting markets and creating unnecessary volatility — especially at a time like this when borrowing costs are climbing and inflation risks are growing. If there is a disconnect between market pricing and their communication, policymakers would normally flag that in the weeks ahead of the next meeting. But then again, never say never when it comes to markets. That is a lesson every trader will learn eventually.

For now, we should still expect the next round of the central bank bonanza to follow the script even after the RBNZ surprise. However, whether policymakers will confirm or contradict pricing for upcoming decisions in the months ahead will be a separate matter.

But given how things have played out with the RBNZ, it is worth remembering that a 90% probability is still, at the end of the day, just a market expectation. It is not a commitment from policymakers to act.

And at a time when central banks are increasingly preferring flexibility over firm promises, traders may have to get accustomed to a little more uncertainty when positioning for the months ahead.