The Reserve Bank’s quarterly survey of semi-expert opinion on the outlook for various macroeconomic variables was out the other day – a bit earlier than usual, presumably because of the changes in the schedule of MPS releases. This is a really rich survey, covering a wide range of variables, and has been running now for nearly 30 years. But I noticed that the number of respondents is now down to only 52 (and on some questions there were fewer than 40 answers). Once upon a time, if my memory isn’t failing me, there were nearer 200 respondents.
My impression is that the Bank’s aims have shifted over time: when the survey began in 1987 it was designed to capture the expectations of people making key transactional decisions in the economy. There were always some economists, but quite a lot of effort went into getting business people and – reflecting the much greater role of collective employment contracts then – union officials to participate. We even had large enough samples that we used to report responses separately for the different classes of respondents. For some years, we ran a staff survey in parallel, which occasionally highlighted interesting differences between staff and external expectations for the same variables. I’m not sure who is captured in the 52 respondents the survey now has, but I suspect economists must now make up quite a large proportion. There isn’t necessarily anything wrong with that – I suspect few people other than economists have explicit expectations for most macroeconomic variables (inflation might be an exception) and if they ever need such forecasts, they will typically draw on the numbers prepared by economists. But it probably means the survey is drifting progressively ever closer to something like a consensus forecasts exercise of economists, rather than capturing how people are necessarily thinking in the wider economy. It is broader than, say, the NZIER Consensus exercise, or than the pool of forecasters the Reserve Bank benchmarks its forecasts against (after all, it includes views of people like me who don’t prepare formal forecasts), but it is a similar class of exercise.
But what to make of the latest survey? Only one thing really took me by surprise and that was that inflation expectations didn’t fall further. I revised mine down, after having been stable for several quarters, and had expected the overall survey to show something similar. After all, the June quarter CPI had surprised on the low side, the exchange rate had increased quite markedly and – for what its worth – the breakeven inflation rates derived from indexed and conventional government bonds had fallen further. In fact, there was barely any change – if anything, a barely perceptible increase.
But it is worth remembering just how very weak these inflation expectations are. The target midpoint – which the Bank is required to focus on – is 2 per cent, and last survey in 2014 was the last time two year ahead expectations were as high as 2 per cent. And that was before the easing phase even got underway. There have only been two quarters in the last four years when one year ahead expectations have been as high as 2 per cent. Many of the deviations aren’t that large, but respondents really don’t believe the Bank will be delivering inflation fluctuating around 2 per cent. That should trouble the Reserve Bank, and must trouble those paid to hold the Bank to account. After all, actual inflation has been below 2 per cent for a long time now.
There is some short-term noise in the inflation expectations series, and there is some seasonality in the CPI. But here is another way of looking at the data. I’ve just averaged the last four observations for each of the four inflation expectations questions (this quarter, next quarter, year ahead, two years ahead) and annualized the two quarterly numbers. In the chart, I’ve shown them against the target midpoint, going all the way back to the end of 1991 – which was when inflation dropped into the target range for the first time.
That prompts several thoughts:
- we’ve never previously seen all the measures below the midpoint. The last eighteen months or so really is different
- we’ve never previously seen the two year expectations measures detach from all the other measures for so long,
- when the shorter-term expectations often ran above the two year measure during the pre-2008 boom, it was the shorter-term measures that better aligned with (I’m hesitant to say “predicted”) what happened to the core inflation measures (the Bank’s own preferred, quite stable, measure peaked above 3 per cent).
The Reserve Bank might defend itself arguing that the fact that the two year expectations are still not too far below 2 per cent is reassuring – “people trust us, despite the short-term variability”. I don’t think that is a particularly safe interpretation – especially when for the shorter-term horizons, about which respondents have much more information, expectations just keep on tracking very low. Another common response from the Bank is to highlight exchange rate and oil price movements – but most of the collapse in oil prices was 18 months ago now, and the current exchange rate is around the average for the Governor’s term to date.
A couple of other aspects of the survey caught my eye. The first was the question about monetary conditions. Here is what respondents said when asked about the conditions they expected a year from now.
For seven surveys in a row, respondents have revised down their future expectations. This question has only been running since 1999, but that sort of run of downward revisions has no precedent – not even during the 2008/09 recession. Typically, the Bank raises or lowers the OCR and people seem to eventually expect policy to work and conditions to get back to normal. You can see that during 2008/09 – by the June 2009 survey, respondents were already beginning to revise back up their future expectations. But not – yet – this time. I’d argue that isn’t surprising – after all, the 2014 tightening cycle was a mistake, and even now with the OCR at 2.25 per cent, real policy interest rates are still higher than they were as that cycle was getting underway. But perhaps there is another interpretation that is more favorable to the Bank?
I was also interested in the responses on expected 90 day interest rates – a close proxy for the OCR. Quarter ahead and year ahead expectations both fell by 10 basis points, but by next June the median respondent still thinks the 90 day rate will be 2.1 per cent. That is probably consistent with the OCR at 1.85 per cent. Respondents expect one more OCR cut – most probably next week, according to the survey responses, but aren’t sure there will be anything much beyond that. Perhaps more surprising, the lower quartile response for the year ahead was 2 per cent. No one can tell the future with any great confidence, but I’d have thought there was rather more of a chance than that that the OCR might need to be cut to 1.5 per cent, or even below, to get inflation back nearer target.
It isn’t obvious how it is going to happen otherwise. Respondents expect GDP growth to remain around 2.5 per cent. And they don’t expect any material further reduction in the unemployment rate – even though I see that Treasury has now revised its NAIRU estimate to 4 per cent – and they expect only as very modest increase in nominal wage inflation (and of course those responses were completed before yesterday’s wages data). It typically takes increased capacity pressure to get an acceleration in core inflation, and there is little or no sign of those sorts of pressures emerging in this survey.
So perhaps what we have is respondents reading the Governor much the way I do – really reluctant to cut the OCR, but he will do so if events overwhelm him (his recent statement suggests next week’s MPS might be that time, if there hasn’t been another miscommunication or policy reversal). But such a stance offers little chance of inflation getting sustainably back to around 2 per cent in the foreseeable future – unless there is some really big unforeseen demand shock.
So those two year ahead survey expectations of inflation still look too high to me. For many years, the ANZ’s survey of (non-expert) small and medium businesses had inflation expectations results above the Bank’s two year ahead survey. Even those non-expert respondents now have (year ahead) expectations of only 1.49 per cent – and that much larger survey has had an upside bias, over-predicting actual inflation, over the years. I still feel pretty confident that the OCR will get to 1.5 per cent before too long – but the sooner it is done, the less the risk of having to cut even further to restore practical confidence that future inflation will be averaging near the target the Bank has been set. Sadly, with only 13 months of his term to go, it seems unlikely that Graeme Wheeler will ever preside over a 2 per cent inflation rate, let alone one that averages 2 per cent. But he can still set a better platform now for his successor.