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ASB economists argue RBNZ should be reducing interest rates; disagree with central bank's view of 'neutral' interest rate setting

Bonds
ASB economists argue RBNZ should be reducing interest rates; disagree with central bank's view of 'neutral' interest rate setting

ASB chief economist Nick Tuffley believes that the Reserve Bank won't cut interest rates next week - but that it should.

The Official Cash Rate set by the RBNZ is currently at 2.75%. The RBNZ has given fairly strong hints it won't drop rates next week, though it does see some further potential easing at some stage. But recent comments suggest the central bank doesn't see the OCR going below 2.5%.

In a preview of the RBNZ's Official Cash Rate decision on October 29 Tuffley says a significant reason for cutting sooner rather than later is the recent rebound in the value of the New Zealand dollar.

"The RBNZ’s medium-term inflation outlook is heavily dependent on tradable inflation rebounding and sustaining a pace at/above 2.5% until 2018, while non-tradable inflation remains subdued. The NZD’s rebound will see inflation languish below 1% for longer, and further delay a return of headline inflation to the 2% medium-term anchor."

Tuffley says the RBNZ appears to be "pinning a lot of hope" on the US Federal Reserve pulling the NZD/USD down by raising US interest rates. (The Federal Open Market Committee also meets next week).

"But, its [RBNZ's] own actions matter. If it chooses to keep the OCR on hold it can hardly complain if markets were to start doubting whether the RBNZ will cut again at all and push the NZD up even further."

Tuffley says over the longer term ASB "are very wary that inflation will not lift to the extent the RBNZ currently expects". ASB's own inflation forecasts, at a 2.5% OCR setting, "do not reach 2% at any point over the next few years".

He believes "there is scope" to drop the OCR below 2.5%.

He points to risks that tradable inflation turns out not as persistently strong over the next few years as the RBNZ assumes, in part due to the recent rise again in the NZD, but also a muted global inflation environment;

He also says there is a risk of wage pressure remaining subdued unless migration slows sharply soon. "We expect an unemployment rate near 7% as opposed to the RBNZ’s forecast peak of around 6.1%, with migration boosting labour supply."

Tuffley believes that house price concerns [raised again last week in a speech by RBNZ Governor Graeme Wheeler] are best left to macro-prudential policy, "rather than holding broader economic growth hostage to those concerns".

And Tuffley says that the RBNZ’s estimate of the "neutral" interest rate "risks being too high".

"Recent research from the RBNZ implies a ‘neutral’ OCR setting is 4-4.25%, but we think this is too high," Tuffley says.

"This research is based off a variety of estimation techniques of this unobservable concept. There is a large degree of uncertainty among the wide range of estimates. A few of these models suggested the neutral 90-day rate was closer to 3.8% (implying around a 3.5% OCR) - which seemed more plausible to us.

"To us, it just does not seem like monetary policy is very stimulatory right now. The extent of stimulus (or restriction) is judged relative to the assumption of neutral. So, another perspective to consider is how the economy is responding to the current level of interest rates. The RBNZ’s 4-4.25% assumption suggests the current 2.75% OCR is 125-150bp into stimulatory territory.

"However, we have an economy that is struggling to grow above 2-3%, with a large degree of slack remaining and unemployment struggling to fall convincingly. Credit growth is positive, but not impressive. It is worth remembering that since the OCR first reached 2.5% in April 2009 it has only been above 2.5% for 28 months out of 77. And the OCR was last at 4% 7 years ago.

"From a risk perspective, deflation is far more dangerous and damaging than inflation being modestly too high. Cutting the OCR might run the risk of inflation flirting with 3% rather than 0.3%.

"Monetary policy is all about making decisions in the face of uncertainty, based off what is expected to influence future inflation outcomes. Inflation could well turn out to do just what the RBNZ currently expects – we just have our doubts.

"If inflation remains subdued there is an opportunity cost of foregone growth.

"To us making monetary policy decisions off a view the neutral interest rate is 4+% feels a bit like lending your car to Thelma and Louise: it may come back washed and waxed – but there is a nagging doubt things may not turn out as well as you’d hope," Tuffley says.

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15 Comments

"To us making monetary policy decisions off a view the neutral interest rate is 4+% feels a bit like lending your car to Thelma and Louise: it may come back washed and waxed – but there is a nagging doubt things may not turn out as well as you’d hope," Tuffley says.

Redefining inflation to affect a redistribution of wealth is just as pernicious for those unable to leverage financial assets due to a compounding reduction in the share of the spoils of capitalism - witness AMP's claims in respect of objectionable NZX50 dividend growth payout rates of 20% versus earnings rising just 3%.

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The RBNZ are telling porkies , and are treating us like idiots .

They know just as well as every reasonably sane educated Kiwi that inflation is close to zero ( our personal fuel and food costs have come DOWN in 2014 and appear to be doing the same this year again )

AND

The Kiwi $ is already way too strong for comfort

AND

The thing we have not been able to measure .................. the so called currency wars ........over the past 2 years are now making themselves felt ....... prices of many overseas manufactures are falling in real terms , so we may to be importing some deflation if we don't weaken our currency

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Don't necessarily agree the $ is too strong, but this looks like the banks trying to increase their margins by driving the underlying cost down. Again banks trying to influence policy.

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Actually most commentators believe banks would benefit more from increased rates and expanded NIM's. http://tinyurl.com/of4erf6

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Pinning their hopes on the US alright. But the US won't pull the trigger until after Q1 next year at the earliest. And if Wheeler and co. leave rates unchanged til then the NZD will keep on creeping. It will at least leave them with ammo should they need it but really they'd be better to get the OCR to 2.5 now to stave off the NZD climbing back over USD.70

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The idea that the 'neutral' rate for the OCR should be 4% or over is bizarre.Of course there are many economic uncertainties,but the balance of risk right now is heavily on the downside.Does anyone believe the official figure of 6.90% for Chinese GDP? The real figure is likely to be under 5%.Where are these hidden inflation pressures?
Yes,the oil price is likely to start rising next year and will be passed on to consumers,but that will also their spending power.

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Its quite likely that the Neutral OCR is more like 2% and for some countries it may even be 0% or negative.

The fact that the RB still thinks of teh days of 4%+ tells me they have no idea what the future holds, zlich, nada.

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Its quite likely that the Neutral OCR is more like 2% and for some countries it may even be 0% or negative.

How is ZIRP working out for the 90% trying to save to get on the mortgage ladder - seems the 10% pulled it up and left them funding the debt?

Property prices in Copenhagen have risen 40-60 percent since the middle of 2012, when the central bank first resorted to negative interest rates to defend the krone’s peg to the euro. The benchmark deposit rate has been minus 0.75 percent since February as Denmark’s currency war intensified, and most analysts surveyed by Bloomberg see negative rates lasting at least through 2017. Borrowers in Denmark can get mortgages as long as 30 years for about 3 percent, while shorter-term loans carry rates close to zero. Read more

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That isnt the context, but rather ask what would be the state of the economy with an OCR of 4% or like some seem to think is "fair" 7%.

Answer in a recession if not a depression. Then those 90% might not have a job in a mega recession so wont be buying anyway, even with the resulting stiff house price drops.

--edit-- followed by an OBR event such that the ppl "demanding" 7% now find they have lost )(some of) their capital as well as the interest they never deserved.

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The counterfactual is without evidence - so let's deal with the facts as they are.

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Evidence that when Sweden raised its rate it went into recession? when NZ did it, inflation collapsed? how many bits of evidence / real world experiments can you reject?

How many actual outcomes can you put forth showing raising the OCR will improve the economy?

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Identify and reverse the trail of enormous wealth transfer that transpired from1982 until recently from labour to capital upon which to apply a different money cost structure. Forever discounting future financial gains with lower rates to capitalise them today has inflicted irreversible damage upon the working classes and that includes you.

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I am all for facts, present some.

Oh and when the OCR is 2% and CPI is 0.4% with the desired point at 2% even simple engineering control theory let alone evidence says open the value and the longer it stays down the more it should be opened.

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Steven.... Do u ever question that premise ...???

The idea that , for some reason, the magical number for the CPi is 2%.... and that to get there we just FLOOD the system with credit/money growth...
Having the CPI at 2% is going to achieve what.???

The outcome of doing that (excessive credit growth ) , for the last 40 yrs, has been the transfer of wealth from labour to Capital... as Stephen puts it.
Seems obvious to me...

You talk about engineering control theory... Can you tell me what the causal relationship is between the OCR and the CPI...???

cheers

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Steven.... the world is almost 8 yrs on from the GFC.... A recession or depression is inevitable.. at some point...
I would rather have it short and hard ...than something that is long and drawn out.... and really brutal
I've followed your posts for along time.... You must find this Global asset boom hard to understand..??
With current Monetary and Govt policies.... asset prices could go much higher... ( thou, of course mkts breath in and out... have pullbacks and corrections )
When the final extreme happens the deflationary implosion will be much worse than it might have been if we had really addressed the systemic problems that became obvious with the GFC... ie.. economic growth thru excessive credit growth..
Thats all we have in NZ....
Our growth is "psuedo growth"... it's the result of using debt for spending....
The lower interest rates are .... the more we borrow....
A household that wants a lifestyle beyond its means ..and borrows to spend, will max out at some point and will have suck it in and feel some "pain"..... so will NZ.. ( the only difference is that NZ can counterfeit Money... but that has its consequences )
Some of us will be able to ride the asset boom wave up and jump off before it crashes.... but really... there should never have been a credit boom wave...
We should have learnt some lessons and had some paradigm shifts from the wakeup call that was the GFC....

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