The Reserve Bank may be fixated on stubborn non-tradeable inflation but its monetary policy is unlikely to be able to get it down to 2% which may not be the optimal level anyway, BNZ Head of Research Stephen Toplis says.
Toplis makes these comments in a note on Tuesday morning's speech from Reserve Bank Chief Economist and Monetary Policy Committee member Paul Conway, the first public comments from a senior Reserve Bank figure this year.
Conway notes non-tradeable annual inflation, relating to inflation from domestic goods and services, in the December Consumers Price Index (CPI) weighed in at 5.9%, above the Reserve Bank's 5.7% expectation. In contrast tradeable inflation, which includes imported goods such as petrol, dropped to 3% from 4.7% as overall annual CPI inflation fell to 4.7%.
“To sum up, monetary policy is working, with the economy slowing and inflation falling. But we still have a way to go to get inflation back to the target midpoint [of 2%],” Conway said, reiterating the central bank's hawkish monetary policy bias.
The Reserve Bank's mandate is to; "achieve and maintain future annual inflation between 1% and 3% over the medium-term, with a focus on keeping future inflation near the 2% mid-point."
'Fixation with non-tradeable inflation'
Toplis reiterates his biggest concern is the Reserve Bank's "apparent fixation" with non-tradeable inflation.
"This was reinforced by Conway’s comment that 'non-tradables inflation is a long way from 2.0%.' It certainly is, at 5.9%, but non-tradables inflation is almost always higher than 2.0%. Since 2000 non-tradables inflation has averaged 3.3%. In the 95 quarters across this period annual non-tradables inflation has been 2.0% or below just six times. Four of those six quarters ended up sub 2.0% because of a big reduction in ACC levies that 'artificially' depressed the reading by around 0.6%," says Toplis.
"Given what is currently driving non-tradables inflation, it is highly unlikely monetary policy will be able to get it anywhere near 2.0% in the foreseeable future. In the last 12 months major contributions have come from: cigarettes and tobacco +11.5%, property rates and related services 9.6%, household energy +5.9%, out-patient services 5.8%, hospital services 12.9%, education 4.4% and insurance 11.9%."
"The Reserve Bank contests that its modelling shows non-tradables inflation is interest sensitive. This may well have been the case in the past but a significant proportion of today’s inflationary pressure will not be so. A substantial proportion of current non-tradables inflation can be attributed to four factors, which are in some cases inter-related: local and central government charges, the country’s infrastructure deficit, the impact of climate change and, increased insurance claims for natural disasters," says Toplis.
He goes on to say the other factor is population growth and its impact on housing and local government costs.
"The Reserve Bank’s actions can do little in this space but act as a barrier to second-round effects."
Although the Reserve Bank can warn government about its policy impacts on inflation it can’t direct policy.
"Monetary policy will not quickly address global warming issues - It won’t improve the weather. It won’t fix Wellington, or anyone else’s, water problems. It won’t curtail population growth," Toplis adds.
In an Of Interest podcast episode in December Toplis argued the Reserve Bank affects tradeable inflation more than it acknowledges, and a lot of the pressure on non-tradeable inflation comes from factors the Reserve Bank can do nothing about. (Listen from 14.55 minutes).
Toplis made similar comments in his CPI preview earlier this month.
'Simply be less dogmatic about getting inflation to the midpoint of the target band'
In Tuesday's note Toplis goes on to question the Reserve Bank's desire to get inflation to the mid-point of its 1% to 3% target band.
"In the recent past our get out of gaol free card has been that we have operated in a world where disinflationary pressures dominated in the tradables’ goods prices space. Tradables inflation over the last two decades has averaged 1.2%. The problem is, and Conway highlighted this, that those things that drove tradables inflation lower are now in reverse."
"The [Reserve] Bank’s view is that this means non-tradables will need to play a bigger role in getting headline inflation down. But given the headwinds to this over the next few years, we would like to think that a better approach would be to simply be less dogmatic about getting inflation to the midpoint of the target band. Alan Bollard, when he was central bank governor was much more relaxed about using the full width of the band. This didn’t seem to cause too much problem," says Toplis.
"And, anyway, even were we to be dogmatic about targeting a mid-point, we have yet to hear a good argument as to why we should be confident that 2.0% is the optimal number. As a point of contrast, if inflation was forecast to be 2.25% in both New Zealand and Australia the Reserve Bank of New Zealand would be running tight monetary policy and the Reserve Bank of Australia loose. Which [central] bank would be right?"
"All that said, it doesn’t really matter what we think about the appropriateness or otherwise of monetary policy settings. The best that we can do is read the Reserve Bank’s tea leaves and try to work out what it is going to do. With this in mind, and based on current information, it would seem to us that the [Reserve] Bank’s economics team will be strongly advising the Monetary Policy Committee, when it discusses its February Monetary Policy Statement, that it should maintain a very similar stance to that which it published when it produced its November instalment. That means limited inclination to cut rates until the second half of 2025 with an even to greater-than-even possibility of a further rate hike. This is a clear warning to financial markets that their pricing of at least three rate cuts this year is inappropriate," adds Toplis.
"Interestingly, financial markets completely ignored that warning today with pricing much the same after the speech as before. Hopefully, this does not act as a red rag to the Reserve Bank bull and tip the Bank into action just to make a point. This certainly cannot be ruled out. Indeed, while we are forecasting the Reserve Bank to stand pat in February you’d have to say that the chances of a hike are much greater than the zero chance of a February [Official Cash Rate] cut."
*Also see the latest Of Interest podcast with Kiwibank Chief Economist Jarrod Kerr including his views on how much the Reserve Bank can influence non-tradeable inflation, and whether its mandate may need changing.
55 Comments
How long do you think the population of NZ will put up with 6% inflation in things they are forced to buy - like food, rent, rates, insurance, electricity? Most people can choose to not buy a new car, or a new iPhone, or go on an overseas holiday, but inflation in the day to day living costs is where it hurts most.
Those 20 years of ignoring non tradeable inflation is why NZ now has one of the highest costs of living in relation to income in the western world. Its also the reason for the mass emigree to Australia.
It wouldn't hurt as much if it were affordable to rent or own a home, and the only way to achieve this is to act at governmental level. If rent was reasonable and house pricing also, then mortgage stress would not be as high, and there would be more disposable income to absorb increases. Instead we have seen 30years of asset growth are set down a path of holding house prices high at any and all cost, even if it means the rent gets hiked, homelessness increases and infrastructure crumbles. Welcome to the decline in living standards we have all been waiting for and watching happen like a slow motion trainwreck.
Yes, turns out that much as commentators elsewhere have suggested, running the economy on the idea of buying and selling existing assets for ever more stratospheric prices was a silly idea and has been bad for society even if some have benefited tremendously from policy.
Sorry. Stopped reading when you said 6% inflation.
The last quarter has the annual inflation rate at 2%.
If you can see anything concrete (i.e. no black swans and no 'maybes') that'll drive it up from last quarter's result then please do share.
Meanwhile, I will point to sub-par growth of 1%, soon to be less, per capita -neg growth, rising unemployment, an export/import slump, a new government hell bent on making contraction and unemployment worse, stable food prices, etc. etc.
It's been trending down since the March quarter, with the exception of September, which can be attributed with some confidence to removal of the fuel/transport subsidy.
It looks pretty likely that we aren't dealing with 6% inflation moving forwards. Will just take some time for that to show in the annual rate.
Big, big call.
I say that because the price of oil has been increasing at a steady rate - a tad, and a small tad, above US inflation - for many decades. Sure, there are blips, both up and down, due to geopolitical events. But the price, when looked at from a longer term perspective, is relatively stable. Thus I expect a slow steady reversion to the mean.
So for oil to be the next driver of inflation in 2025 we'd need yet another oil shock. The flash points that would cause an oil shock are already 'flashing' so it would need to be a new one, or a dramatic escalation of an existing one. I can't see any new ones large enough to create a shock as existing producers can increase supply to mitigate the impacts. And I can't see any of the flash points already flashing as getting much worse.
But you may be in good (and I use that term loosely) company ... The RBNZ is predicting elevated oil prices that are way outside the historical range.
See Figure 6: Nominal New Zealand ex-oil import prices and projection (TWI terms)
https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/events/2024/0…
On page 6.
I can imagine situations where their projections may be correct but the circumstances required to justify those outcomes are extremely unlikely and all require significant disaster events. (One scenario is that the RBNZ holds rates high for so long we enter a recessionary doom spiral and they have to drop the OCR to extremely low levels to restart NZ Inc. and the NZD drops way significantly. Are they that stupid? I'm beginning to wonder.)
However, the RBNZ makes no attempt to explain these projections in Conway's paper..
As a result - I'm calling b.s. until they do.
One of the key issues for me, is that we seem to have a domestic situation that cannot be kept in check for one reason or another. Local govt costs are spiralling upwards, with the service levels we receive way below what we would expect in many cases [roads]. Ditto central govt overheads, huge salaries to people producing minimal value leading to poor outcomes across many of our state institutions [take your pick]. Both these are leadership issues & both of them are failing to deliver [in a huge % of instances]. Regulation overload is killing creativity & thus opportunities for people to get on & create valuable products & services and well paid jobs. When you kill innovation, as the Labour/Greens/left of centre just love doing, we all end up the poorer, sadly. This too is a leadership issue.
So why are we so dumb at leadership? Most of it can be traced back to very sub-par standards of education which has been going on [mainly downwards] for more than 5 decades that I can recall. International tests results lay this fact bare. Indeed, we are failing in so many ways that we think it is normal, especially when we reward people for doing so [welfare]. It has to stop. Please N/ACT/NZF, it has to stop.
Anecdotally what I have seen and heard from within govt sectors in leadership is a lack of integrity due to fear. Fear that speaking your mind in leadership meetings due to saying something that could be "career limiting" even if you disagree with what others are saying, or getting shouted down if you do and be labelled confrontational or worse. Leaders afraid to discipline staff for poor performance as it was so hard to find and to keep staff when salaries were going up and up 2020-2022 that leadership would rather retain their staff performing poorly than lose the knowledge and skill base that the staff have by means of attrition, as staff could up and leave at the drop of a hat for another job with better money. Couple this with hiring for reasons other than merit, e.g with so much attrition, the last man standing is best set for a leadership role even if they don't have the attributes for it, and also blanket pay increases across the board as opposed to recognising individual performance. All of this is still being felt and it will take a couple of years to revert or reign in this culture as well as get the productivity push ingrained back into staff.
I'm not sure long those adverts will be around. The woke public servants pushing that crap will soon be gone. Hardly anyone speaks any Maori, so if you are looking for someone that is qualified for the position and speaks Maori, then the talent pool will be very shallow indeed. You might as well start recruiting people that only speak Latin. You may get more candidates applying.
Requirement is a push, but I'm all for it if they wish to support people learning Maori. It isn't the language that is doing any harm to NZ at all, it is the overcooked mentality of those hiring that they have to hire specific types of people as opposed to those best suited for the job by merit.
This would explain the policy to turn property from a free market with risk and downward price discovery allowed, into a welfare scheme for those who were given affordable housing earlier. But unfortunately NACT look only likely to try to push and inflate even further in that same direction, not to reward and incentivise hard work and productive business investment instead.
The Reserve Bank contests that its modelling shows non-tradables inflation is interest sensitive
Then why was non-tradables averaging over 3% for the last 20yrs? Unless all that matters to the RBNZ is the overall inflation being within 1-3%? Looking at the last quarter, annualised, the overall inflation rate is 2%. Seeing as OCR changes take 18mths to affect the economy, then why keep the foot on the brake?
"High" interest rates don't need to reduce the cost, they just need to reduce the increase in price.
Its much harder to increase the price when the economy isn't doing very well. Councils will be cutting back on all but the vital services. Landlords won't be able to pass on rent increases if their tenants have no extra money to pay for it. Insurance companies will have to find a way to reduce their costs.
Sorry Jimbo but the evidence points against that so far. Councils are not constrained. Landlords may eventually hit a limit but don't seem to be there yet. Insurance companies just keep increasing premiums as they see fit, and decline cover to those who aren't prepared to pay.
Cuts to services you get for your rates is a bit like Cadbury halving the size of their chocolate bars and saying they didn’t increase the price. The CPI should catch that sort of thing as your purchasing power of your money is being eroded. It is tough for insurers to cut cost as the risk they are insuring is increasing. I think the OCR is the wrong tool to fix insurance premiums, rates and rents. Regulation is adding costs to insurers and rents. These costs are unavoidable.
"It is tough for insurers to cut cost" - they are a duopoly remember. One way to cut cost is to charge by risk, our insurance companies don't tend to do that as they don't have competition doing it, most of the risk is subsidised. If some policies were abandoned due to risk exposure while other polices drop in price, the CPI would probably see this as a reduction.
Fair enough point about the Cadbury comparison, but I doubt the CPI takes that into account for these types of items.
Insurance is about spreading the risk and charging a margin for doing so. If they go more granular with pricing, it will cause increases for some and decreases for others. It may not result in cheaper premiums over all. There is also significant cost involved in doing so.
This was reinforced by Conway’s comment that 'non-tradables inflation is a long way from 2.0%.' It certainly is, at 5.9%, but non-tradables inflation is almost always higher than 2.0%. Since 2000 non-tradables inflation has averaged 3.3%. In the 95 quarters across this period annual non-tradables inflation has been 2.0% or below just six times.
Generally commodity prices have settled into a stable pattern again and China has started to export goods deflation: https://www.ft.com/content/ccb13d73-f875-43a8-89c7-9d4a611588cb
I don't think Reserve Banks will need to do much more for now to quench inflation, they'll hope they can just hold rates stead and left inflation com back to target.
However I think you'll find the appetite for big stimulus greatly diminished. That era may be over.
I think they will get CPI inflation back to 2% (and probably already have). But I am not so sure they could decrease interest rates and maintain that 2%.
Will higher interest rates destroy economies? Or will economies eventually pick up like they always do (with some people taking a bath)? I doubt the RBNZ is concerned about a recession, but if it becomes a full on depression then we may have to reassess.
I think the takeaway from all these bank economists doing interviews on this topic is that, the banks would really like it if there were some rate cuts as soon as possible.
I don't think banks are enjoying these higher rates at all. Things must be starting to get difficult.
Economists are practically pretty brain dead.
High OCR and High Interest Rates are "INFLATIONARY" !!!
Like Oil, they increase the cost of everything, as finance is a major cost of all business, so they are creating Inflation themselves.
If they had half a brain, they would have a compulsory Kiwi Saver where the contribution rate is moved up and down to control inflation.
Taking money out of spending pockets and encouraging saving instead.
I think the best way to control inflation is to ensure we have genuine competition. Genuine competition will lead to innovation and productivity improvements. This is the only way everyone can win. The OCR is basically a way to destroy demand so prices don’t increase but someone ends up screwed with lower profits or even losses. It only works for short periods or it leaves a real mess.
So rates are one of the key drivers of the non-tradeables they are trying to reduce, the below is copied from our (QLDC) last statement explaining rate increases:
Higher interest rates – due to the tightening of monetary policy from the Reserve bank; aggressive increases to the Official Cash Rate (OCR) (5.5%) over past 12 months has seen the weighted average interest rate increase from 2.64% (June 2022) to 4.84% (April 2023). The overall effect of the rise in interest rates and the increase in borrowing is a forecast increase in interest costs of $10M for the 2023-2024 year. This is the major factor in the higher than expected rates increase.
That means limited inclination to cut rates until the second half of 2025 with an even to greater-than-even possibility of a further rate hike. This is a clear warning to financial markets that their pricing of at least three rate cuts this year is inappropriate.
At least it's a clearish signal for the next 18months. SFL. Sticky for longer.
I think we're all missing the point. Money needs to flow and circulate, not be stockpiled in assets, in the hands of a few.
We'd be best to eliminate the need for continuous debt creation at the bottom. This and the higher debt loads are the root causes.
Competing against each other does not improve societal/community outcomes, it's a zero sum game. It's even less effective now when the big players buy up their competitors. We think competition exists when we have many brands to choose from and fail to see the illusion when 99% of them are owned by a few.
Cooperation is required for a greater vision than more profit, more money. Cooperation creates unity not competition.
Everything above are moot points. They're outdated beliefs. Our economics, our power and control structures are failing humanity.
Toplis didnt really come up with a solution - he identified that non tradeables inflation has been above target for 20+ years - said its a problem then said dont worry or just change the target.
The answers are frankly rubbish - it has been above target for 20+ years and it is a problem showing up now in our high cost economy - and will get worse if tradeables inflation doesnt drop quickly or far enough
So yes we need a central govt to get its act together, living within its means and managing immigration. We need the commerce commission to do its job, ditto local govt where rate increases have outstripped inflation as services decline -I am sure others can name additional actions required
and it would help if economists like Toplis were more demanding of the NZRB and offered solutions rather than platitudes
On the other RBNZ article I posted the follow:
Moronic stuff.
Take one example: "He said capacity pressure—or the balance between supply and demand in the economy— mattered most for inflation targeting, rather than the overall size of the economy itself."
I'd say capacity pressure is indeed a massive problem. But NOT for the reasons they say.
The primary reason is our extremely low levels of productivity and the enthusiasm by business to add labor when capital investments in plant and machinery would create greater productive capacity, and most importantly, capacity elasticity!
Until we get greater capacity elasticity into our businesses, by increasing our collective investment in plant and machinery (and management skills), we'll continue to be bound by this nonsense (while suffering slow, non-meaningful growth associated with importing more labor).
But guess what?
Will businesses invest in greater productive capacity (and elasticity) when interest rates are high?
NO - THEY BLOODY WELL WON'T.
My solution, in the paragraph (starting "Until we get greater.."), addresses one of the biggest issues we have in NZ. The solution would need to be multi-facetted.
- Tax treatments of real investment need to change to that businesses invest more into their ability to supply (capacity) and can quickly and easily ramp-up production (elasticity).
- We need a banking system that favors such investment. (E.g. other countries have "development banks" specifically for this purpose. These are partly government funded and they offer lower interest rates to genuine investors. Our current banks simply price loans for investment at whatever they think the investors can handle thereby strangling all investment to their terms.)
- We need kiwi business leaders to be better educated and thinking longer term.
- Did you know that overseas investors think we're so green that building anything new is a pain-in-ar##? This isn't actually true as our 'green' regulations are actually below standards set in many parts of the USA. What does happen is that nationally significant supply gets held up at the regional and local levels as NIMBYs come out in forces to block any progress on their 'patch'. This needs to change. Both regional and local governments need powers to reign in NIMBYs and land bankers that hold up development.
- We need to hold the owners of monopolies and oligopolies feet to the fire so they invest in additional capacity before it is needed rather than play inflationary pricing games until they feel like adding additional capacity. I.e. in a country as small as NZ relying on 'competition' to do this is absurd.
- We need to encourage overseas investors into building new capacity where they will create genuine competition.
Can you see the NACTF doing any of that? Or Labour/Green? No? Me neither.
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