The Reserve Bank of New Zealand (RBNZ) held the cash rate steady at 5.5% on Wednesday, but indicated a potential easing of monetary policy over time if inflation decelerates as anticipated.

The decision aligned with the expectations of all economists surveyed by Reuters, but the central bank’s accompanying commentary was more dovish than many had predicted.

“The Committee agreed that monetary policy will need to remain restrictive. The extent of this restraint will be tempered over time consistent with the expected decline in inflation pressures,” according to the statement.

At the previous meeting in May, the RBNZ said policy was forecast to stay restrictive for a “sustained period”, and signalled a rate rise was a possibility if inflation wasn’t brought under control.

The New Zealand Dollar dropped by 0.74% to $0.6085 as markets anticipated an earlier onset of rate cuts, causing it to reach a 16-month low against the Australian Dollar. 

In addition, two-year swap rates decreased by 11 basis points to a six-month low of 4.6850%. This suggests an expectation of 25 basis points of cuts in October.

“The RBNZ sounded rather dovish in its commentary.  The Committee's messaging gives us greater confidence that the Bank will commence its easing cycle in November,” said Abhijit Surya, Australia and New Zealand economist at Capital Economics.

The central bank forecasts headline inflation to return to within the target band of 1% to 3% in the second half of 2024, a fall from 4% in Q1.

Although Q2 inflation data is not being released until next week, components like food prices, which are released monthly, have begun to show signs of moderation. Additionally, inflation expectations are declining, and there is a lack of confidence in business outlooks.

“Some domestically generated price pressures remain strong. But there are signs inflation persistence will ease in line with the fall in capacity pressures and business pricing intentions,” the RBNZ said.

The rate hikes have significantly slowed down the economy, although recent data indicated that New Zealand exited a technical recession in the first quarter of this year, recording a growth of 0.2%.