The Reserve Bank’s Monetary Policy Committee adds the word ‘confident’ to its inflation forecast, even as hot CPI release looms

The Reserve Bank (RBNZ) appears cautiously confident the policy settings it landed on a year ago have been enough to tame the forest fire of inflation.

Monetary policy works with infamously long and variable lags. In New Zealand, it can take up to two years for higher interest rates to take full effect on the real economy. 

It has now been two and a half years since the RBNZ started tightening policy and almost a year since it hit pause on the OCR at 5.50%. 

That meeting in May 2023 was the first and only time the RBNZ's Monetary Policy Committee has had a split vote, with two of the seven members voting to hold the OCR at 5.25%.

Since then, the policy position has been ‘watch, worry, and wait’. 

The Committee faced an anxious 18-month wait for the September quarter of 2024 when the central bank’s mathematical models predicted inflation would fall below 3%.

April’s policy review reads as though the decision makers feel they are entering the final stretch with growing confidence they made the right call.

It’s a cautious confidence though. The statement used one of its only eight sentences to point out central banks around the world were worried about easing policy too soon. 

Near-term trouble

The Consumer Price Index data release, due out on April 17, is likely to be higher than forecast due surprisingly strong prices in a handful of luxury goods. 

Stats NZ’s new selected price indexes showed big moves in restaurant food, domestic airfares, and overseas accommodation. The latter alone could boost the annual print by 0.4 points.

Stephen Toplis, head of research at BNZ, said this was a “very strong argument” for why the central bank should pay closer attention to core inflation — despite targeting the headline. 

RBNZ Governor Adrian Orr made a speech earlier this year in which he emphasised the bank was effectively targeting core inflation and would look through noise when appropriate. 

BNZ’s forecast predicts inflation will be 0.8% in the March quarter and 4.2% on an annual basis, considerably higher than the 0.4% and 3.8% the RBNZ is expecting.

It is numbers like these that give some pause for thought. Inflation has been above target for about as long as anyone is willing to tolerate, including the Committee. 

Infometrics was sufficiently spooked by the pressure to push its prediction of rate cuts back from the August meeting to November.

“We expect it to be a close-run thing whether inflation gets back within the 1% to 3% pa target band by the end of this year, or whether it takes until early 2025,” Gareth Kiernan said. 

Even so, the central bank should have enough confidence to cut rates at the end of the year. Although they may not foreshadow them as doing so would risk undermining market interest rates.

May, may not 

The Monetary Policy Committee said the economy had evolved as anticipated since the February meeting. It has also played out roughly as expected in May last year.

Gross Domestic Product is slightly weaker but mostly due to historical revisions. Headline inflation has fallen faster but non-tradable prices have been considerably above forecast. 

Unemployment is creeping upwards but remains quite a lot lower than was originally imagined. The labour market is one of the last things to react to higher interest rates.

Despite some variation in the data, the Committee strengthened its language. It described itself as being “confident” inflation would be in the target range “this calendar year”. 

The word confident is new in that context. The Committee had previously “noted” that inflation was “still expected” to fall into the target band in the second half of 2024.

Last week, UBS economist Nic Guesnon previewed the April policy review with a warning that it could be financial stability concerns that force earlier rate cuts. 

That idea also got a shout out in the record of the meeting, with the Committee warning inflation could decline more rapidly than expected.

“Business and consumer confidence remain particularly weak which could lead to more unemployment and financial stress than expected,” they said. 

The RBNZ will give its financial stability assessment next month and it could add some colour to how much pressure monetary policy is putting on the economy.