While the Reserve Bank’s Monetary Policy Committee is reasonably confident inflation will drop back to the midpoint of its target range over the first half of next year, its chief economist acknowledges he's nervous inflation could get embedded in peoples' expectations.
The Reserve Bank (RBNZ) is charged with maintaining inflation between 1% and 3% and it specifically targets 2%.
In the June quarter, annual inflation as measured by the consumer price index (CPI) was 2.7%. The CPI figure for the September quarter comes out next Monday but last week, the Committee noted inflation is projected to have reached 3% in this quarter.
“When you’re forecasting inflation to be 3%, there’s a good chance that it prints a bit higher than that, meaning you’re outside of your target,” RBNZ chief economist Paul Conway, a member of the Monetary Policy Committee, says.
“So we’re kind of balancing up that risk against the risk of a more prolonged period of excess capacity in the economy which is a key driver of medium-term inflation pressures.”
Conway’s comments on Wednesday come a week after the RBNZ’s Monetary Policy Committee cut the Official Cash Rate to 2.50% from 3%.
A rate cut was expected but economists were divided between 25 basis points, which would put the OCR at 2.75%, and 50 basis points. Some warned against overreacting while others said monetary stimulus was needed.
'As required'
On the decision to cut the OCR 50 basis points, Conway says the Committee was; “open to further reductions in the OCR as required to ensure that inflation settles around that midpoint”.
“‘As required’ is the key phrase in that sentence, essentially what we did last week.”
Conway says "we'd previously signalled that we thought there was about 50 bits [basis points] to go".
“We got a very negative second quarter GDP number. We think part of that is statistical noise or seasonal balancing factors that will dissipate."
“We think part of it is on the supply side of the economy. So particularly high electricity prices putting the squeeze on manufacturing and a little bit at the margin, it increased our measures of excess capacity in the economy, but it definitely increased the risk of a more prolonged period of excess capacity in the New Zealand economy," Conway says.
“So we brought forward that 50 basis points easing and made the point that it’s rebalancing those risks so that risks going forward are more balanced.”
While financial market pricing implies a good chance of more rate cuts, Conway says; “we’re getting going on our November monetary policy and we’ll have a good running of the ruler over that.”
The November Monetary Policy Statement will have; “a full forward-looking endogenous rate track and answer the question of where the Committee thinks the trough will ultimately prove to be,” Conway says.
Asked how the Committee squared the decision to cut 50 basis points when it came to inflation with the single mandate, Conway says it’s forecasting inflation to go to 3% in the September quarter; “and that’ll be a big piece of data that will feed into the November policy round”.
“We understand why inflation is around 3% - a lot of that is non-market factors like rates, car rego - all that sort of thing is holding it up there."
“If you took all of that out, it would be around the midpoint of the target. We also think that, given we’ve got spare capacity in the economy, and have had for well over a year now, that it’s not the environment in which businesses will be lifting prices.”
Nonetheless Conway acknowledges being nervous "because there is a risk that inflation gets embedded in peoples' expectations and it could be more prolonged."
When asked about interest rates being in stimulatory territory and whether the RBNZ will need to hike the OCR back up to a neutral level it doesn't view as stimulatory or contractionary, Conway says he thinks there’s a lot of uncertainty around where neutral really is.
“It’s more of a zone than a specific number. And in different markets that are influenced by interest rates, neutral can be different. I think it’s a rough approximation of an abstract concept.”
Conway says there’s not a magic number the OCR goes past which is considered stimulatory and therefore you have to rebound.
“The other thing is that neutral is moving around quarter on quarter as well. So for us currently, it’s more about feeling our way - what effects are we seeing interest rates having on the economy and that tells us how stimulatory or otherwise we are being.”
The RBNZ will have one more monetary policy review in November before the new governor, Anna Breman, starts in December.
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6 Comments
Stagflation may have arrived. The RBNZ are walking into it with their eyes wide open and fully cognizant of the risk. But they are also being asked to do too much on their own - the government has to increase spending to support monetary policy. The RBNZ can't do all of the heavy lifting.
If the OCR continues dropping, inflation stays above or close to 3% and the economy stays down - what then? What moves does the reserve bank have after that? They are trapped at that point.
But they are also being asked to do too much on their own - the government has to increase spending to support monetary policy.
Quality of spend, not quantity. $50 million on consultations / feasibility studies for cycle bridges is great for funding kitchen renos for a select few.
But it has limited benefit for the nation and the people.
When countries like Japan spend, they get tangible outcomes that benefit society and the economy. They're not perfect, but they have a comparatively high success rate on delivery.
There is also an additional risk of the value of the NZ dollar falling and making imports more expensive. This will act as an inflationary force. The lower interest rates go the higher the chances of a fall in the NZ dollar. It signals that our domestic economy is weak and contracting.
The RBNZ are walking a tightrope in 3 different universes all at the same time. There are so many moving parts to this and they are all alone when it comes to starting the (long awaited) economic recovery. My economic perspective tells me they can't do it without fiscal policy alignment.
This seems like an odd thing to say. Having just dropped the OCR, they must be pretty sure inflation is going below 2%. Otherwise why would you drop the OCR when your only mandate is to keep it at 2%?
The government explicitly stripped them of their dual mandate of employment and inflation down to just inflation. So your question is valid - why go on about "spare capacity" (code for "oh fuck, this is not good") when that is not the RBNZ's concern?
It seems obvious that they are trying to revive the economy even though they shouldn't give a toss. Which is good IMO, but not exactly in alignment with the inflation only mandate.
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