Opinion: Don't cut willy-nilly, Mr. Bollard: cut OCR by 75bps
22nd Oct 08, 5:34pm
By BNZ Markets Senior Markets Economist Craig Ebert While the Q3 CPI came in bang on expectations "“ at 1.5% (5.1% y/y) "“ and is surely the peak, its detail proved more robust than we anticipated, in the areas the Reserve Bank would be the least comfortable with. Sure, this won't stop the Bank easing aggressively this Thursday, and then some. However, the stubborn elements of recent inflation, even after the very clear recessionary phase to date, are a reminder that Alan Bollard needs to be careful about cutting the OCR willy-nilly based on other, attention-grabbing, considerations. We can't easily dismiss the fact non-tradables inflation, for example, picked up to a quarterly 1.3%, from 0.9% (meaning the jump in its annual pace, to 4.1%, from 3.4%, was about more than just the policy-related "dipper" of 0.6% in 2007 Q3 dropping out of the calculations). As part of this, housing-related inflation remained stubbornly strong. Prices for the purchase of new homes increased 1.3%, following Q2's 1.1% and Q1's 0.9%. Rents rose 0.8%, following 0.7%. More generally, trimmed-mean inflation picked up to 1.3%, from 1.2%, while the weighted-median version of core inflation lifted to 1.0%, from 0.8%. The yearly rates for these core measures edged up to the 4.0% region, on average. Even the proportion of prices that rose (as opposed to dropped or remained unchanged) during the September quarter increased further. Yes, we fully appreciate the inflation process works with a long lag. And so these latest CPI data don't deny the broader inflation outlook is seen shrivelling, as demand keeps slowing both here and abroad. Indeed, we believe the very next, Q4, CPI out-turn will flatten to a bare 0.1%, as the recent collapse in commodity prices (especially fuel) comes through, on the way to headline inflation fading to 2.2% over the coming twelve months. This is why we continue to see a flashing green light for the forward-looking RBNZ to cut rates. All the same, today's September quarter CPI details are a gentle reminder the Bank needs to be wary of slashing and burning its OCR before all the boxes are ticked on the presumed, but still necessary, subsidence in headline and core inflation, from their recent uncomfortable peaks. It's not as though we haven't had a collapse in GDP growth. Indeed, we've seen nothing but contraction for this year. And consumer and housing demand have been running below-par for even longer. Imagine where inflation would be heading if this hadn't have been the case. We've needed every drop of the downturn to get on top of inflation, and would seem to need even more to suffocate it entirely. The other little warning against the Reserve Bank culling its cash rate with gay abandon, right now, is to do with the exchange rate. It has already fallen a fair bit on a trade-weighted basis this year (might this be an overlooked reason core CPI inflation hasn't fallen by more than might be expected on sheer demand considerations?) We believe the TWI will keep moderating "“ as an important form of monetary policy "reaction" to the global economic and financial deterioration. To be sure, none of this should stop the Bank following through on an easing cycle substantially greater than it envisaged just six weeks ago. The cycle should get the OCR back to neutral, sooner rather than later, with a good chance that cash ends up on the easy side, in effect. This has been our tack for ages now. However, we also need to note the financial markets are now presuming an unprecedented cut of 100 basis points for this Thursday's OCR review and with a further 75 points seen sliced off in early December. Yes, this would be a justifiable response to the way the world economy has become so distressed and the credit markets so bunged up. However, we must ask, will the RBNZ feel entirely comfortable about rubber-stamping the lot of it, especially when the need for a collapse in NZ inflation, at this stage, remains much more certain than its eventuality? This is part of the reason we have opted for a 75, rather than 100, point cut for this Thursday, and why we have also stuck with a 50 points off for December, rather than 75. To be sure, these are not times to be splitting hairs. However, the core inflation annoyances in this morning's CPI would seem to support a less, not more, aggressive stance "“ as does, incidentally, the way bank bill spreads to cash have started to reduce, as some of the worst credit fears abate, for the moment. All of these things remain important, at the margin. And, on balance, they counsel against the RBNZ throwing all caution to the wind, when simply a good proportion of caution will do. * This economic outlook was written by BNZ's Senior Markets Economist Craig Ebert. All of the research from the BNZ Markets team of economists is available here.