The Official Cash Rate has hit 1.5 percent, increasing by 50 basis points from 1 percent, the Reserve Bank confirms.
The increase is the largest since May 2000. It comes after the Official Cash Rate came off its emergency 0.25 percent setting in October, put in place at the start of COVID-19.
Delivering the second Monetary Policy statement of 2022, the Reserve Bank said on Wednesday the hike was needed to best maintain price stability and support maximum sustainable employment.
"Moving the OCR to a more neutral stance sooner will reduce the risks of rising inflation expectations. A larger move now also provides more policy flexibility ahead in light of the highly uncertain global economic environment," the statement reads.
The Reserve Bank said global economic activity continues to generate rising inflation pressures, which are exacerbated by ongoing supply disruptions driven by COVID.
It said the Russian invasion of Ukraine has significantly added to these supply disruptions, causing prices to spike in internationally traded commodities and energy.
"There is an elevated level of uncertainty created by the persistent impacts of COVID-19, and clear signals that monetary and broader financial conditions will tighten over the course of 2022. Added to this is the high level of geopolitical tension and related economic sanctions on Russia," the statement said.
Overall, the NZ economy continues to be resilient but the Reserve Bank said Omicron is still disrupting economic activity.
"Heightened global economic uncertainty and inflation are dampening consumer confidence. The rise in mortgage interest rates – amongst other factors – have acted to reduce mortgage demand and house prices.
"However, economic capacity pressures remain, with a broad range of indicators highlighting domestic capacity constraints and ongoing inflation pressures. Employment is above its maximum sustainable level and labour shortages are impacting many businesses."
Brad Olsen, the principal economist at Infometrics, told AM ahead of the RBNZ decision that a 25 basis point jump was "the absolute minimum".
"Realistically, we know that we've got inflation running at a generational high. We've got the unemployment rate at a record low," he said.
"The pressures in the economy are intense and the longer we leave it without aggressive action, the harder it could become to unwind that level of inflation and the harder hit that New Zealand households would be."
Olsen said the central bank would have to "seriously toss up" a 50 basis point rise, something it hasn't done since May 2000.
While the RBNZ does sometimes make big moves pulling the OCR down - as it did during the Global Financial Crisis and at the start of the pandemic - it's cautious with big jumps upwards due to the effect on interest rates. The bank did mull over the idea of a 50 basis point jump at its last meeting in February, but went with the more conservative 25 basis points.
"We haven't seen such a big increase in quite a while, and so 50 basis points is certainly what we think needs to happen to try to get inflation under control," Olsen said.
"But the Reserve Bank is really trying to grapple with just how quickly it tries to get inflation under control at the same time as just how much they try to curb economic activity."
How does it affect you?
Olsen said it's likely mortgage rates will increase.
"Remembering that middle of last year, you could get a one year fixed mortgage rate for 2.2 percent, you're now looking at 4.5 percent, if not more. We're picking that one year fixed mortgage rates will be above five percent by the end of the year.
"All of that suggests that these increases to the OCR will see households paying more when it comes to mortgages, but that's also going to reduce just how much money they're spending in other areas, which is very uncomfortable but quite important when we know that the economy is currently spending above our means."
He said middle and lower income Kiwis are "feeling the pain quite hard in their pockets", so a jump in the OCR would be "bitter medicine to swallow, but in the long run will make us feel a lot better".
The RBNZ's remit sees it required to keep inflation between 1 and 3 percent on average while also supporting maximum sustainable employment. The latest inflation data is out next week, but in January StatsNZ found inflation had jumped 5.9 percent in the year to December 2021, the largest jump since 1990.
"We know that fuel prices have massively increased since then," Olsen said. "We know that talking to a lot of store owners, a lot of households, a lot of businesses, prices have continued to go up."
"So now mind that inflationary pressure is even higher. We're picking a 7 percent inflation rate this quarter, so the Reserve Bank will want to be combating that."
The March ANZ Business Outlook survey said inflation is "moon-bound", pointing to a "remarkable" net 96 percent of businesses who reported facing higher costs. All of those surveyed said that meant they intended to rise prices of goods and services.
Olsen said it's "great news" that unemployment is currently at a record-low 3.2 percent, but there are concerns that "wages aren't keeping up with inflation".
"Inflation, like I said, 5.9 percent, wages up only 3.8 percent. What that means is that people are getting into work, yes, but they're also not getting nearly as much money.
"They're actually going backwards in real terms. The worry is that we're very much overcooking the economy. The Reserve Bank will be trying to limit that activity back."
With consumer confidence seriously down and the continued effects of Omicron, Olsen said the RBNZ will be thinking that "if they go too hard, they might kneecap the level of economic activity".
"In my mind, we're already starting to hit those capacity constraints in the New Zealand economy. If we don't get this inflation under control, it's going to be a very uncomfortable battle," he said.
"The Reserve Bank's going to have to make even greater increases over the next 12 to 18 months to get this inflation dragon back under control."
What's happening overseas?
It was revealed overnight that inflation in the United States rose 8.5 percent in the year to March, the largest annual increase since 1981. It was up 1.2 percent over the month, the biggest monthly gain since 2005.
Inflation has been soaring there recently off the back of the international supply chain issues, but US President Joe Biden on Wednesday put the blame squarely on Russia's Vladimir Putin.
"Your family budget, your ability to fill up your tank - none of it should hinge on whether a dictator declares war and commits genocide a half a world away."
Olsen said the US Federal Reserve is now looking at rising their equivalent to the OCR by 50 basis points.
"One of the central banks out of Europe increased 100 basis points in one meeting. That's one whole percentage point. So you are starting to get this feeling that after central banks, including New Zealand, have been caught on the hop, have been acting too slowly, they're really starting to get going at the moment.
