There's definitely some risk attached to the approach the Reserve Bank (RBNZ) has taken in its first Official Cash Rate (OCR) decision of the year and accompanying Monetary Policy Statement (MPS).
The background to this decision was interesting. If we recall, late last year the RBNZ followed a jumbo 50 point cut to the OCR, with another 25 point cut in the decision on November 26.
With the benefit of hindsight, it seems the RBNZ was, prior to the jumbo cut, thinking that it had about 50 points worth of cutting still to do. It went for the jumbo cut in October because of the clear signs the sought-after economic recovery was faltering and, well, people needed cheering up. They needed an excuse given to them to go out and spend some money.
Having used up its 50 points in one go then, the RBNZ was faced with the choice of either ending the cutting cycle there and then, which would have just seemed plain strange after a double-cut, or going ahead with another 25 point cut it reckoned we didn't really need.
So, it went ahead in November with the non-needed cut, but was reasonably clear that this one would be the finish.
The financial markets responded to that fairly definitive sign from the RBNZ by immediately looking for when the next RISE in the OCR might happen, and therefore wholesale interest rates surged, sufficiently that banks then felt they had to start raising mortgage rates.
This was, no doubt, a very surprising development just before Christmas and a rather rude way to send people off on their summer holidays.
Very odd situation then. Central bank drops the key interest rate, but monetary policy is effectively tightened.
The mortgage rate killer
And, while it's early days yet in terms of getting official economic data through for late last year and early this year, clearly those upward moves in mortgage rates were enough to get our hesitating economic recovery hesitating even more.
The housing market seemed to have been flattened by it in January, for example.
Financial markets were pretty much expecting the OCR to start rising again in September of this year. If the RBNZ had backed up that expectation with its new OCR 'forward track' projections in the latest MPS , then the financial markets would have probably reacted by pricing in an even earlier start to hikes. More upward pressure on mortgage rates might have ensued.
What the RBNZ has done in its projections (page 40) in the latest MPS, is give a just over 50% chance that the OCR will move up in the December 2026 OCR review, and an over 100% chance it will have risen in the February 2027 review. But only by 25 basis points. And then there's no aggressive portrayal of rises from there. The forecast timeframe ends in 2029, at which time the projection is for a 3.0% OCR.
Some of the bank economists were, and I dare say still are, expecting more than that. For now though, the financial markets have backed off, and are now obediently pricing in the first OCR rise for December.
New RBNZ Governor Anna Breman, overseeing her first OCR review, was explicit in wanting to give the economic recovery every chance:
We do see that we are in the early stages of an economic recovery. But it’s true that many households will not feel this yet. They’re still feeling the high inflation that we had over the past few years. Many businesses are still struggling,” Breman said.
But what we are seeing is that the data is showing us that we are at the early stages of a recovery and we want to keep the OCR on hold to support the recovery while ensuring that inflation falls back to target.
The alternative to this approach would have been to signpost OCR hikes - but at what cost to the recovery?
It could cut both ways
The reality is that there's risks both ways. Take what many regard as the 'prudent' approach, and signal hikes to counter inflation, and this could squash the recovery.
The approach that the RBNZ has taken - which as I said at the top is, I think, a calculated gamble, is to give that recovery the best chance of taking hold - but with the risk that inflation does overshoot. And as we saw in the wildness of the 2021-22 period, when annual inflation shot up from 1.5% to 7.3% - if this thing gets away on you, it can be hard to rein in.
An obvious question at this point, I guess, is why - when the RBNZ's mandate is to achieve 1% to 3% inflation - is it gambling on inflation getting away, in favour of giving the economic recovery a boost? Isn't it operating outside of its specific brief?
Well, of course there's another risk attached here, which is that if the RBNZ went all heavy handed with the OCR now, it could, by crushing the brittle confidence and therefore smashing the economic recovery, cause inflation to tank completely, below 2% - which is the RBNZ's explicit target.
So, in reality the risk with foreshadowing rate rises is that the central bank could cause inflation to undershoot its target, while the opposing risk is that by giving the recovery a chance and depending on inflation to behave...well, it could get away. Risks on both sides. Hey, this monetary policy stuff is not easy!
Inflation - you behave yourself - there's an economy at stake here
Therefore we are depending on inflation to behave. How are we doing on that score then? We know that annual inflation as measured by the Consumers Price Index (CPI) ticked up to 3.1% in the December quarter from 3.0% previously, putting it outside the 1% to 3% target range.
The first sneak preview of what might happen in the current (March) quarter was provided by the Selected Price Indexes (SPI) for January. It was a decidedly mixed bag.
The SPI includes around 47% of the ingredients of the CPI, but importantly, in terms of letting economists predict what the CPI outcome might be, it includes the more volatile bits of the CPI that are difficult to estimate.
The eye catching part of the latest SPI release was the 2.5% increase in food prices in January, the biggest rise in four years. That WAS offset though by still low rentals. lower power increases, a retracement of some of December's big rise in airfares and accommodation costs, while fuel costs came down again.
The economists seem to be reckoning, based on this early indication, that the March quarter CPI might show an annual rate of inflation of 2.7% or 2.8%, which would of course get it back into the 1% to 3% target range. The RBNZ itself is forecasting 2.8%.
All things considered then, I think the RBNZ has taken the right approach. We do need to give the economy a chance.
It's risky, but it's a risk worth taking.
*This article was published in our email for paying subscribers early on Friday morning. See here for more details and how to subscribe.
20 Comments
Met the ceo of trademe last week, who is also Swedish...
Winston is asleep at the wheel here, all these Swedes flooding in and taking our jobs!
🥂🤑
Based on your comment the other day saying "praise Allah," I'm guessing you're a Swedish Muslim living in New Zealand, or are you just trolling? Are you also French speaking?
Another way to interpret the RBNZ caution is to assume a weak economy in 2026 - unemployment is predicted to keep rising and if inflation is coming back into band without an OCR hike that tells us the economy is still contracting and demand is not coming back in 2026.
If that isn't the case then the RBNZ are deliberately allowing inflation to run above the 3% upper bound to protect the economy. Which is not anywhere in their mandate.
It's not in their mandate but they'll certainly cop flack for killing growth by focusing too hard on inflation.
The RBs mandate is a funny thing. It exists but also doesn't.
I believe outside of their mandate, there's also a core mission of the health of the economy or something (it's on their website somewhere).
It feels like the RBNZ is trying to make up for absent fiscal policy and that is not something they can do with the OCR alone.
In other words 'we are happy to continue to erode the purchasing power of the money in distribution in our economy, in order to save our economy'.
In other words we are willing to make you poorer and your living standards worse (that is what inflation is), in order to save the economy in which you participate.
Completely bonkers in my opinion.
If only it were that simple. The RBNZ has to consider causing further economic contraction and inflation falling below the 1% lower band. Deflation is considered as much a risk as inflation. i think they are in a bind and trying to avoid stagflation - that is the big risk in 2026. It's a risk the Ozzy banks and markets have already signaled by raising forward looking interest rates.
Deflation is considered as much a risk as inflation.
It's considered worse. With deflation, the general price level falls but nominal debts do not, so the real value of fixed debt obligations rises; borrowers must repay in “more expensive” money than they borrowed. This debt-deflation dynamic squeezes households and firms: more income goes to servicing old debts, less to current spending and investment, which further depresses demand and prices.
Now consider this. At the peak of its epic bubble, Japan’s household debt to GDP was approx 50–60%. In the case of Aotearoa, it's closer to 100%. The Anglosphere is terrified of a Japan debt deflation scenario. For good reason. If the sheeple do not accumulate debt at an increasing rate and vol, things will go backward very quickly and quite possibly worse than Japan - which was still a net creditor, productive economy, and saver when everything went to seed.
There's one key indicator of permanent decline.
It's not here yet.
Well P, you can champion Ponzinomics as the only savior, but you have to be able to accept the consequences and trade-offs. Naturally the boomers are clinging to the status quo and the younger demogs are having to deal with the negative implications. Not sure that they have the power and chops to change things for the better.
Not sure that they have the power and chops to change things for the better.
Not once they’ve bought a house
Sorta like how hippies and millennials all talked a big game but eventually worked in cubicals and joined the machine.
You're confusing my statements of facts as advocation for them.
If our population becomes unable to increase, I'm sure we"ll end up in the same place. As have the likes of Greece, Portugal, etc.
But unlike them we're a multicultural society speaking a language common in 100 countries so can attract as many migrants as there are ones that want to leave where they are for somewhere better.
"In order not to kill our fragile economic recovery" - should not be any concern of the RBNZ. Like I have said all along, they have an unofficial dual mandate - people don't like being made unemployed, and the RBNZ don't like making people unhappy. There is no other reason not to increase the OCR right now unless they really think there is a risk that CPI will fall below 1% which seems like a very small risk.
Consideration of unemployment was removed from the RBNZ mandate by the coalition that we elected in 2023. If the RBNZ is concerned about unemployment as inflation breaches the 3% upper band then they are deliberately ignoring their explicit single mandate.
Higher unemployment is the favored tool of employers and the business sector for keeping inflation in check. It improves worker retention and kills wage rise demands. This is why the RBNZ was instructed by the government to ignore unemployment in its OCR settings and focus solely on inflation staying in band.
Yep I understand that. So do you seriously think the risks are balanced right now, inflation is just as likely to go under 1% than it is to stay over 3%, hence keep OCR as it is? I certainly don't, there seems to be way more risk of it going over 3% (in fact it already is) than going under 1%. If I was only concerned about CPI I wouldn't have made the last 2 cuts and/or I would have hiked.
Seems to imply to me that they aren't just thinking about CPI.
We have to be conscious of what the RBNZ say, vs what they do. Their communications are an intentional tool to signal to the economy. But their actual behavior is driven by more considerations than the CPI.
Otherwise there'd just be a matrix of where the OCR has to be relative to inflation, and they needn't tell us anything else.
But they have a single mandate (well also financial stability but that isn't in question right now). Why would their actual behaviour be driven by more considerations than the CPI. Like I said they do actually want economic growth and low unemployment even though they shouldn't give a toss, and they are prepared to ignore their mandate slightly to achieve them. Which isn't a bad thing IMO, but why not just put that in their mandate (unemployment being a secondary goal when CPI near target)
The inflation rate is the ultimate yardstick they are measured by, but that doesn't mean it's the sole consideration they will take when making decisions. They will sometimes state those in the press announcements - the advent and ramifications of COVID, as an example.
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