More OCR cuts are on the way - RBNZ

Further monetary policy easing and exchange rate depreciation are required for the good of economy, Reserve Bank governor Graeme Wheeler said in a speech in Tauranga this morning.

Of late, the New Zealand economy has experienced a series of shocks - notably plunging dairy prices.

Wheeler said there were risks and uncertainties around the inflation outlook and that, despite recent declines, the exchange rate remains too high for current economic conditions. 

“At current levels of export prices, a more substantial exchange rate depreciation will be required to stabilise the net external liabilities position relative to GDP.”

He noted that current monetary policy settings are providing stimulus to the economy when growth is around 2.5%, which is slightly below potential. 

However, Wheeler poured cold water on the idea that extensive interest rate cuts are on the way this year.

He said the large declines in interest rates predicted by some could only be consistent with the economy moving into recession. 

Contrary to this, the RBNZ believes several factors are supporting economic growth. 

These include the easing in monetary conditions, continued high levels of migration and labour force participation, ongoing growth in construction, and continued strength in the services sector.

In returning inflation to the mid-point of the target band, the RBNZ has to avoid unnecessary volatility in output, interest rates, and the exchange rate.

Wheeler said that aiming to return inflation to around its medium-term target level in about nine to 12 months’ time is an appropriate speed. 

But, as the economy is constantly experiencing shocks and disturbances, policies may need to change, he continued. 

For this reason, the RBNZ regularly reviews and, where necessary, revises its policy settings to meet its price stability objectives.

The RBNZ will be reviewing its growth forecasts in the September monetary policy statement.

Meanwhile, the RBNZ remains conscious of the impact that low interest rates might have on the housing market, Wheeler added. 

Lower interest rates could exacerbate the existing housing pressures in Auckland by further stimulating housing demand. 

However, in the present situation, raising interest rates would be inappropriate as it would put upward pressure on the exchange rate and further dampen CPI inflation, he said.

While the RBNZ remains concerned about the financial stability risks posed by a major correction in Auckland house prices, it believes that macro prudential policy is the most helpful way to ease some of the pressure.

The proposed LVR measures and the policy initiatives announced by Government in the 2015 Budget should begin to ease the impact of investor activity, Wheeler said.

“A strong supply response over several years is needed to address Auckland’s housing imbalance.

“But macro-prudential policy can help to lower the financial and economic risks while important regulatory and infrastructure issues are addressed and additional investment in new housing takes place.”