Reserve Bank of NZ could soon stop buying Govt bonds

The Reserve Bank has been buying Government bonds for more than a year. Photo / Supplied

The Reserve Bank, which has been buying government bonds at the rate of $200 million a week, might stop buying them altogether in the coming months, BNZ interest rate strategist Nick Smyth reckons.

Smyth said the market continues to bring forward the expected timing of Reserve Bank official cash rate hikes.

The central bank has been buying government bonds since early last year as part of a range of measures aimed at keeping interest rates low in order to soften the blow to the economy posed by the Covid-19 pandemic.

The market has priced in February as being the point when the official cash rate would gain by 25 basis points, and some pricing suggests that a rate hike may occur before the end of this year.

Higher interest rate expectations have driven the 2-year swap rate up by 4.5 basis points higher, to 0.77 per cent - its highest level since March last year.

The New Zealand 10-year swap rate was 2bps higher on Friday, to 1.92 per cent.

Smyth noted that the Reserve Bank, in a routine announcement last Friday, planned to buy just $200m in Government bonds this week, down from $1.8 billion a week at the start of the Covid-19 pandemic early last year.

"With nominal government bond issuance stepping up to $500m this week, from 300m previously, this means the market will need to start absorbing more supply," Smyth said.

The market's reaction may provide some clues as to how the market will adjust when the Reserve Bank stops purchases altogether, Smyth said.

"Taking market pricing at face value (a greater than even chance of an OCR hike in November), the implication would be that the Reserve Bank might stop quantitative easing purchases in the coming months, since the RBNZ would want to stop adding to its stock of bond holdings before it starts raising the official cash rate," Smyth said.

The OCR has been sitting at a record low of 0.25 per cent, where it has remained since March last year.

Recent events have encouraged economists to re-assess their interest rate expectations.

First, there was data showing the economy grew by 1.6 per cent in the March quarter -- easily double the most optimistic of expectations.

Then, in mid-June, New Zealand wholesale interest rates bumped up the US Federal Reserve signalled that it expected to start raising interest rates in 2023, driven by faster growth and higher inflation.