Flexibility key to RBNZ policy

In a speech to the Canterbury Chamber of Commerce today, Reserve Bank Governor Graeme Wheeler came out swinging at those who have been pushing the case for further OCR cuts.

Some commentators see a low headline inflation number and immediately advocate interest rate cuts, he said.

“But a mechanistic approach to interpreting the Policy Targets Agreement (PTA) could lead to an inappropriate fixation on headline inflation.

“It would cut across the flexibility deliberately built into the PTA framework, and risk creating serious distortions in the financial system, housing market, and broader economy.”

Flexibility is necessary as the RBNZ has to take a wide range of often uncertain factors into account.

These include asset prices, financial stability and efficiency, volatility in output, interest rates, and the exchange rate.

Wheeler said the RBNZ aims to anchor inflation expectations close to the mid-point of the price stability target range.

“It retains the discretion to respond to inflation and output shocks in a flexible manner.”

New Zealand’s current annual headline inflation rate is sitting low at 0.1%.

This is primarily because of the negative inflation in the tradables sector, particularly the decline in oil prices, Wheeler said.

“Low oil prices are recognised in the PTA as a factor that can legitimately cause inflation to be outside the target band.

“It would be inappropriate to attempt to offset the low oil price effect through the OCR, which tends to influence inflation outcomes over an 18 month to 2 year horizon.”

While headline inflation may be low, New Zealand’s annual core CPI inflation of 1.6% is within the RBNZ’s target range.

Wheeler said the RBNZ’s combined measures of annual inflation expectations, averaging 2%, are more encouraging, but he wouldn’t want to see inflation expectations become unstable and decline significantly.

Overall, the RBNZ’s outlook for the New Zealand economy is positive, with growth forecast to increase to an annual rate of 3% and inflation projected to move back within the target band. 

However, there are greater uncertainties around the economic outlook than normal, and the balance of risks lies on the downside, Wheeler said.

“Foremost among these risks are the difficult external environment, weak commodity prices, and unusually strong net migration flows.”

This environment could leave the door open for further interest rate cuts – if the RBNZ’s concerns deepen.

Wheeler said if that should happen some further policy easing may be needed over the coming year to ensure future average inflation settles near the middle of the target range.

“These issues and the requirements in the PTA mean that there is much to consider in determining monetary policy that extends well beyond the current level of headline inflation.”

Meanwhile, the RBNZ is still concerned that imbalances and rampant house price inflation in the Auckland property market pose a financial stability risk.

While recent indicators suggest Auckland’s market might be beginning to slow as a result of new tax and LVR measures, the RBNZ is waiting on the February and March 2016 data to get a better feel for the situation.

But Wheeler added that the RBNZ’s macro-prudential policies have played an important role in reducing the risks associated with the growth in bank lending.

“Across the banking sector the share of high LVR lending (LVRs of 80% or over) has fallen from 21% of overall housing lending before the introduction of LVRs, to 13% currently.”