Roger J Kerr looks at the official interest rate 'forecasts' by the RBNZ and sees them more as working assumptions, changeable as circumstances alter

 By Roger J Kerr

My observation is that the markets make far too much out of the RBNZ’s official exchange rate and interest rate forecasts published in their regular monetary policy statements.

A cynic could suggest that the exchange rate and interest rate forecasts are calculated by solving a number of factors backwards.

Start with the fact that the RBNZ always must have a 24-month annual inflation forecast of somewhere very near to the 2.00% mid-point of the 1.00% to 3.00% allowable policy band.

To do otherwise would be in breach of their policy targets agreement.

Therefore to keep inflation at that level in two years’ time requires interest rates and the exchange rate to be at particular levels as the demand and pricing transmissions work through the economy.

The RBNZ cannot just produce a GDP growth forecast and then accept the inflation figure that drops out of the bottom of that process.

What if the resultant inflation number is 3.5%?

So, to me the TWI and 90-day interest rates are assumptions that are adjusted to get the outcome they need; that is, 2.0% inflation.

Therefore, they are not forecasts as most would understand them and a lot can happen to the economy in the meantime that renders that forward guidance out of date.

In particular, global foreign exchange rate movements well outside the RBNZ’s control and influence can have a massive impact on the NZ economy and inflation rate.

Tradable inflation would increase a lot sooner/faster if the USD was to suddenly strengthen, sending the NZD/USD rate well below 0.8000.

The RBNZ would be forced to increase the OCR earlier and in larger steps than the track they have indicated.

Alternatively, a continuing weak USD currency on global markets may allow the NZD/USD rate and TWI to go higher still, resulting in lower inflation, a weaker economic performance and thus a much slower pace of interest rate increases.

I still favour the former.

Nothing is set in stone, and the RBNZ assumptions are as changeable as anyone else’s.

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Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com