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Opinion: Why bank economists are getting their forecasts so wrong
February 9th, 2010
By Roger J Kerr
There were no surprises with the weak employment data last week, causing both interest rates and the NZD to decrease.
Yet again the moneymarkets and bank economists have been forced by the economic facts to push their timing of OCR interest rate increases back to June/July form the previous March/April predictions. Go back a couple of months to early December a number of the bank economists were confidently predicting the first OCR increase in January 2010.
Unfortunately you never see any explanation as to why those forecasts were so wrong.
These interest rate forecasters are either just guessing with these very changeable predictions, or they are just so removed from what is actually happening in NZ businesses and industry sectors that their economic theory always dominates over the reality.
According to the economic theoreticians that still seem to hog the media headlines here, the cause and affect chain goes as follows:-
“Low mortgage interest rates
+ high immigration inflows
= rising house prices
= increased borrowing ability to fund household spending
= higher retail sales
= stronger demand pushes up retail/consumer prices
= higher inflation
= RBNZ tightens monetary policy
Result: higher interest rates and higher NZD currency value”
There are flaws with this theory in every one of the links in the above chain:-
1. Floating and one-year mortgage interest rates may be lower than historical averages, but the upward sloping yield curve has term mortgage rates at or above average. There is no certainty that immigration inflows will be so positive this year with more Kiwis expected to depart for Aussie than last year.
2. House prices have been rising due to a shortage of new listings, however upcoming tax changes are certainly now putting a damper on the rental investment property market.
3. The banks have fundamentally tightened credit and lending criteria on home mortgage borrowing as well as business lending. Property developers have very limited sources of debt financing. The credit environment today compared to three years ago is massively different.
4. Consumer confidence surveys may suggest growth in retail sales in 2010, but we have not seen any uplift yet. Expect this week’s December retail sales data to be not much better than flat. Retail goods financiers are only talking about arrears, defaults and bankruptcies, thus their acceptance criteria have tightened dramatically.
5. We have not observed “demand-pull” inflation as a source of inflation for more than 10 years in New Zealand. Consumer goods prices continue to fall due to the NZD currency impact and extraordinary competition.
6. The inflation outlook is benign; the RBNZ are in no hurry to do anything.
7. The net result of the economic reality being diametrically opposed to the economic theory is … interest rates lower for longer and a lower NZD value.
However, there has to be a major qualification to the “interest rates lower for longer in 2010” view, and that is based on the NZD/USD exchange rate.
A continuing weak Euro currency over coming months is expected to lower the NZD/USD rate (we follow the EUR against the USD) to 0.6500 and maybe lower. A lower NZD value, coupled with excellent commodity export prices will spark increased activity, confidence and investment in our big export industries. In turn that would cause us to lift our GDP forecasts for 2010, and that in turn would bring forward and increase associated inflation risks. A lower NZD value automatically eases monetary conditions, therefore the RBNZ would need to lean against that with higher interest rates earlier.
—————-
* Roger J Kerr runs Asia Pacific Risk Management. 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
Tags: EUR, GDP, Household spending, immigration, mortgage interest rates, NZD, OCR, RBNZ, Roger J Kerr, USD
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February 9th, 2010 at 10:36 am
Doesn’t this analysis also suffer from an adherance to present monetarist dogma – that being that consumer/commercial “interest rates” are coupled to a Federal Reserve’s OCR. And isn’t that the very part of the system that is a total joke at present?
February 9th, 2010 at 11:35 am
“Go back a couple of months to early December a number of the bank economists were confidently predicting the first OCR increase in January 2010″
To be fair to the banks, I don’t remember anyone saying January. In fact the closest we got was when Westpac suggested it as a possibility when shifting up to March.
In November, the majority of bank economists were still picking September for the first rate increase – and as stronger than expected data came in (and the RBNZ’s own shifting forward in the signaling of increases to mid-year) out over the close of last year they shifted their timing forward to June, and then some banks moved to April (and Westpac, for a little while, went to March).
February 9th, 2010 at 3:43 pm
Don’t sweat it too much Matt – Roger is constantly throwing up strawmen to hide the crappiness of his own forecasts. Pretty much every point he makes here is wrong:
1. The slope of the yield curve is irrevelant, because people have the sense not to borrow at those higher rates. Bear in mind that the ’cause and effect’ chain that Roger sets out is the counterfactual, i.e. what would happen if short-term rates stay low forever.
2. It’s total nonsense to simply say that there’s a shortage of listings, as if supply was the only determinant. More accurately, there’s a shortage of listings to meet the very clear rise in demand.
2a. How’re those “upcoming tax changes” working out for ya?
3. Banks have loosened, not tightened, lending standards on housing lately (or at least they’ve given that impression – more likely, they simpy didn’t advertise low-equity loans during the recession).
4. We actually have seen an uplift in consumer spending. Ex-auto retail sales are up 4% on a year ago. Car registrations, which fell hard during the recession, are up 50% from their lows. The figures out on Friday are expected to show real retail sales (excluding price effects) went up by 1.5% in the December quarter alone.
5. If we haven’t had “demand-pull” inflation then presumably Roger thinks we’ve had “cost-push” inflation. It’s true that many costs have been rising, most notably wages, but these price increases had their origins in strong demand, not supply shocks.
5a. Consumer prices do not “continue to fall”. We’ve got a currency at the upper end of its historic ranges which can’t act as a deflationary force forever, and we’ve just had the deepest recession in 20 years. If the RBNZ can’t get inflation any lower than 1.7% in those circumstances, then why would anyone believe that they can keep it “comfortably” within the target during better times?
In fact, we can see that people don’t believe it – surveyed inflation expectations began to rise even before it was the that the recession had ended. Expectations for two years ahead are now at 2.6%, and that’s with the expectation that interest rates will rise.
End rant
February 10th, 2010 at 2:50 pm
@Miguel Sanchez: “Surveyed inflation expectations began to rise even before it was the that the recession had ended. Expectations for two years ahead are now at 2.6%”
What does “Surveyed inflation expectations” have to do with reality? so some ppl were asked what they thought was going to happen in the future? lots of crystal balls for sale? luck? stupidity? listening to the Pollies and economists who obviously have little idea what tomorrow holds and are hog tied by their own political ideology or broken economic theory anyway, this sounds really sane and reliable.
“Roger is constantly throwing up strawmen to hide the crappiness of his own forecasts.” He seems to be more on the ball than bank economists, who frankly are a joke…So the bank economists have told their management that rates will rise so price up accordingly…and it might yet stay at 2.5% OCR for a decade….its prefectly true we might see 15% Interest rates in 3 years….but that does not make the bank economists guesses any good…
“It’s true that many costs have been rising, most notably wages, but these price increases had their origins in strong demand, not supply shocks.”
I certainly dont agree, demand is very subdued….credit card /eftpos purchases up? no not from what I can read. Around me ppl who I know seem to be living with wage no increases, small increases or worse shorter working week….or
Look at the contents of some produce…smaller quantities at the same price (Chocolate) and / or cheap fillers replacing the quality items….Whitlocks chunky tomato sauce, now has 6% less apple and a large % less tomato (they dont say), its filled with corn syrup and flavourings instead….so its 32%+ sugar up from 22%…manufacturers are cutting costs because they cant raise prices…then look at TVs/Computers/whiteware etc…
Somehow we need to sort out the real from what is not and quickly….you cannot manage anything if you dont know were you are and what’s ahead.
regards
February 11th, 2010 at 2:10 pm
Hi steven – good comments, happy to answer them.
“What does “Surveyed inflation expectations” have to do with reality?”
- If people think that the central bank will tolerate inflation of 3% then they will attempt to set their own prices accordingly. That makes it that much harder for the RBNZ to keep inflation down around 2% (if in fact that is their intention at all). Expectations are not the be all and end all, but they’re pretty important.
“He seems to be more on the ball than bank economists”
- Technically, bank economists haven’t yet been ‘proven’ wrong about an April hike, the date hasn’t passed yet! That aside, Roger’s economic arguments have little to do with why economists may end up being wrong – frankly if I believed his story then I’d be wondering whether April or June would be the first CUT, not hike.
Everyone, including the RBNZ, realises that rate will have to go up eventually, to avoid feeding another housing bubble; the question is when and how fast. That’s a question of the RBNZ’s response function, not the facts – it’s a matter of playing the man rather than the ball.
“I certainly dont agree, demand is very subdued”
- I was referring to Roger’s comment that we haven’t seen demand-pull inflation in the last 10 years. We have seen inflation in the last 10 years, so presumably Roger believes it was cost-push, i.e. rising prices for inputs, including wages. Wages did rise at an increasing pace through most of the last decade, due to a shortage of workers – but that was caused by strong hiring demand, which in turn was because firms needed more people to meet strong demand for their products. It was very much demand-driven inflation. And it will return in time if the RBNZ keeps rates low for too long.
“credit card /eftpos purchases up? no not from what I can read.”
- There’s an ongoing shift away from credit cards. But total spending is on the rise.
“Look at the contents of some produce…”
- Inflation is a drop in the ‘bang for your buck’, whether it be through higher prices or shrinking portions (which Stats do attempt to adjust for, by the way).
“look at TVs/Computers/whiteware etc”
These prices have been in steady decline, even when general inflation was high. Also, people tend to assume that because these are big one-off expenses that they make up a large share of total spending; they don’t. We spend more in a year on cigarettes than we do on TVs and computers.
have a nice day