Reserve Bank defends route it took to land OCR at 1% ahead of house-buying season
Thursday, 14 November 2019
ANALYSIS The Reserve Bank has batted off a suggestion that it made a tactical error by slashing 50 basis points off the Official Cash Rate in August and then holding the rate on Wednesday.
An irony of the two decisions is that the OCR is now exactly where the banks were expecting it to be in the forecasts they were making in July – at 1 per cent – but they have been wrong-footed twice on the route it took to get here.
ASB chief economist Nick Tuffley argues the path the Reserve Bank has taken has backfired, with wholesale interest rates back to where they were before August's 50bp OCR cut.
That was 'just ahead of a crucial period for the mortgage market and with the RBNZ's next decision window three months away', he added.
The criticism may not be sour grapes.
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If there is one simple message the Reserve Bank wants the market to take on board, it is that interest rates will remain low for a long time.
But by cutting deep in August and then holding rates this week, the trajectory for the OCR might seem stronger than if both 'points on the graph' in August and November had pointed downwards.
It is understood the 50bp cut was 'a line call', and Reserve Bank chief economist Yuong Ha says that not cutting again on Wednesday was also a close decision.
But it is possible to argue the toss on what the upshot has been, he says.
If the bank had taken 'two bites of the cherry', as ASB suggested it should have done, 'it would have been well-choreographed and you don't know what market pricing would have done,' Yuong says.
'The currency might not have reacted at all, and we have seen that in the past where the central bank is the last to act.'
Taking a longer term view, mortgage rates are down between 50bp and 100bp since the start of the year, and the New Zealand dollar is down about 5 per cent 'so that is unambigously stimulatory', he says.
Overall, criticism of the Reserve Bank's latest interest-rate call has been muted.
That may reflect the fact that it is hard to argue with its central thesis that the current OCR setting is already below inflation and delivering a strong stimulus, and that economic indicators since August provided it with little clear justification for additional action.
Neither can any of the banks claim to have been led astray by the Reserve Bank's prior commentary.
While the big five banks all forecast a rate cut, Westpac was wavering up to the last minute and BNZ had noted the Reserve Bank did not seem committed to a cut, and BNZ was adamant that one wasn't needed.
Where to from here?
While ANZ is forecasting two more cuts in February and May that would take the rate down to 0.5 per cent, that appears fairly speculative at this point.
Its forecast is partly based on the assumption that economic growth will come in lower than the Reserve Bank is forecasting.
BNZ's very different assessment is that rates are now on hold for the foreseeable future, though with a possibility of a cut at some stage in 2020.
It is also possible to plausibly argue that the next move in the OCR may even be upwards, though not perhaps before the second half of next year.
Although much will depend on the international environment, there were a couple of signals in the Reserve Bank's latest monetary policy statement that it might be more alert to 'upside risks' just beyond the horizon.
Government accounts are moving into surplus and there is an election next year.
Finance Minister Grant Robertson does not appear likely to miss the obvious political opportunity to open the purse strings.
Yuong says it would be 'natural' for people to conclude that with the Government's books in good shape and an election coming up, there could be promises from both main political parties, though he says that would not be something the Reserve Bank would directly factor into its rates decisions.
'We don't explicitly account for hypothetical government spending or policy changes because of all the second-guessing and unhelpful dynamics.
'But to the extent it goes beyond rumour, that will affect household and business behaviour and that is something we will pick up.'
Another development highlighted by BNZ research head Steve Toplis is that the Reserve Bank has dropped its estimate of the level of economic growth that can be achieved without an uptick in inflation.
'The key to the RBNZ's reluctance to reduce its cash rate stems from its enlightened view on the economy's potential growth rate,' he says.
'For a long time now we have been stressing that softening investment growth and restricted labour productivity meant the economy simply could not grow as fast as we have become accustomed to. Belatedly, it now appears the RBNZ has come to that very same view.'
All other things being equal, any growth much in excess of 2 per cent will cause inflation to rise and, more importantly, the current slowdown in growth will not be sufficient to see inflation fall away to disconcerting levels, Toplis says.
Yuong confirms the bank is seeing 'grow slow', after looking back at data over the past year.
'Data suggests that even though growth has slowed, businesses are close to full capacity and inflation really hasn't fallen away.
'The way we square that up is saying that tells us that the potential growth capacity is a bit lower and, going forward when growth does recover, it doesn't have to recover so sharply before it starts generating some of the inflation pressure that we are forecasting.'
While that mitigates against interest rate cuts, that's a bad thing, of course.
Lower net migration and a plateauing in labour force participation – the proportion of adults wanting work – could be among the underlying causes, Yuong says, with an increase in investment to raise productivity the potential cure.