Once again the Reserve Bank and its Governor have started backing away from a view that interest rates are low enough to get inflation back fluctuating around the 2 per cent midpoint of the target range – the focus the Governor and the Minister agreed on just over three years ago.
Two years ago, with the OCR at 2.5 per cent, they were gung-ho on the need to raise the OCR – quite openly asserting that they expected to raise the OCR by 200 basis points. From the January 2014 review:
The Bank remains committed to increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point.
As late as December 2014, with the OCR now at 3.5 per cent they still thought
Some further increase in the OCR is expected to be required
By June last year, they had belatedly started cutting the OCR, and then thought only perhaps 50 basis points of cuts would be required.
By last month, they had got to 100 basis points of cuts, fully reversing (at least in nominal terms) the 2014 increases. While not totally ruling out the possibility of further cuts they observed of the target midpoint that
We expect to achieve this at current interest rate settings
Today, that optimism has gone and we are back to
Some further policy easing may be required over the coming year to ensure that future average inflation settles near the middle of the target range.
I guess that is their bottom line, and I suspect the forecasters are giving the Governor little reason for much optimism. No doubt the “over the coming year” is designed to discourage people from focusing on the March Monetary Policy Statement, but as ever the data flow will determine that. Most likely, the Governor will have to shift his ground yet again – as he continues, for year after grinding year, to be over-optimistic about the likely rebound in inflation and (indeed) about the strength of the (per capita) economy.
But he must be a bit torn. Almost everything in today’s statement that deals with what has already happened would be pointing towards further OCR cuts (weaker global growth and rising uncertainty about it, falling international commodity prices, continuing weak New Zealand export prices, and weak inflation here and abroad). Add to that the Governor’s continuing unease about the exchange rate – when it weakens it is usually a sign of weakening economic prospects, but the Governor still thinks it is too high.
So he seems to rest his case on two arguments.
The first is that New Zealand’s inflation rate isn’t very low after all.
Headline CPI inflation remains low, mainly due to falling fuel prices
But that just isn’t even factually accurate. The target inflation rate is 2 per cent, and the latest headline inflation rate was 0.1 per cent. But the inflation rate excluding petrol prices was 0.5 per cent. Excluding all vehicle fuels and household energy costs it was 0.6 per cent. And if we take something like the common international ex food and energy measure, SNZ tells us that inflation excluding food, household energy and vehicle fuels was still only 0.9 per cent last year.
And it isn’t government charges or tobacco taxes either – as I noted last week, in highlighting that the inflation rate is the lowest in 70 years – the impact of higher tobacco excise taxes and cuts in government charges totally offset each other in the last year.
Everything seems to rest on the Bank’s sectoral factor model measure of inflation – which, as I noted last week, has increased somewhat to 1.6 per cent for 2015. This has been the Bank’s preferred measure of core inflation over the last few years, but it is quite unusual for a model estimate measure of core inflation to make it into the OCR press release. Indeed, I went back quickly and looked at the OCR press releases since the start of 2013, and not a single one of them referred to a core inflation measure, let alone quoted a specific number.
The idea behind the sectoral factor model is sound, but it seems rather bold for the Governor to put so much weight on this particular measure when it seems to be at odds with the other indicators of underlying or core inflation. I’ve already quoted some of the exclusion measures (the CPI ex petrol, or whatever), but the other core inflation measures on the Bank’s website have also been flat or falling. At the other extreme, the trimmed mean measure of inflation was only 0.4 per cent last year. Oh, and inflation expectations – survey measures and market ones – have been low and falling.
I’m not sure what the “true” measure of underlying inflation is – and neither is the Governor – but I don’t think the overall balance of indicators should be giving the Governor any reason for confidence about the current situation of the inflation rate relative to target. It certainly isn’t all about petrol.
The Governor also apparently remains optimistic about a re-acceleration in economic growth in New Zealand:
growth is expected to increase in 2016 as a result of continued strong net immigration, tourism, a solid pipeline of construction activity, and the lift in business and consumer confidence.
But….even if immigration remains high, that only maintains growth rates and doesn’t provide a basis for any acceleration (especially as the Bank in its most recent MPS announced its conversion to a view that immigration did not put any net pressures on demand, even in the short-term – a change of heart which they have still not justified, or released any supporting papers for). When I last looked, international guest nights growth looked to have levelled off quite markedly in the second half of 2015, and any lift in business and consumer confidence still looks quite modest (and certainly hasn’t taken any of the measures back above where they were earlier last year). And all that is before we take into account the continuing weak international dairy prices (weaker than the Bank, and most producers will have been expecting), and the increasingly difficult international environment. There is plenty of volatility in quarter to quarter GDP growth rates, and plenty of revisions too, but there doesn’t seem to be much there to give us confidence that economic growth in New Zealand will pick up materially, if at all, this year. And inflation was already weak, and weakening, even when the economy seemed stronger, and income growth higher, 12 to 18 months ago.
Yet again, the Governor is behind the game – grudgingly adjusting his line to barely keep up with the deteriorating flow of domestic and international data. We might worry less if the weak inflation was the result of strong and resurgent productivity growth, but there is no sign of that either. Instead, we’ve been left with an anaemic recovery and a high unemployment rate (rising over the last year). Not everything is down to the Reserve Bank’s failures, but the Governor’s choices haven’t helped – monetary policy is designed to deal with demand shortfalls. The Bank should be held more forcefully to account for those choices.
In closing, I was sobered to look at the inflation rate ex food and energy. New Zealand’s is 0.9 per cent. That for the euro-area is 1 per cent. The gap isn’t large, but with plenty of policy room at the Reserve Bank’s disposal, they really should have been able to keep inflation a lot closer to the target midpoint than the ECB – grappling with the zero bound, and all the existential issues weighing on activity, demand and investment in much of the euro area.