Doubling down on OCR cuts being some way off

In a highly anticipated RBNZ webinar this morning, Conway says downward revisions to economic activity do not mean there is no inflationary pressure in the economy.

Stats NZ last year significantly revised its historical GDP data to show the economy being nearly 2% smaller than it was previously and last week’s CPI data showed inflation falling faster than the RBNZ had predicted but this was mainly because of low imported inflation figures. Domestic inflation remains high.

Conway says it is capacity pressures – the net balance between supply and demand in the economy – that matter most for inflation.

“Yes, lower GDP indicates weaker demand, but also the productive capacity of the economy is lower than previously assumed. That is, the recent GDP revisions do not necessarily mean that capacity pressures in the economy are much lower than previously assumed.”

Digging into the expenditure, Conway says GDP data reveal that weaker real government expenditure accounts for much of the revisions and some are due to methodological changes, such as Stats NZ now accounting for school attendance when measuring value added by the education sector.

Private demand in the economy, which is more interest-rate sensitive, has mostly been revised up, with stronger consumption and business investment than first reported, he says.

“While GDP has been revised down, net inward migration continues to be revised up, with estimates of about 250,000 migrants entering New Zealand over the past year while just over 120,000 people left. That’s a net gain of almost 130,000 people, or nearly 2.5% of the population.”

Conway says there are no hard and fast rules about the inflationary impacts of migration, but a strong inward migration has clearly helped alleviate labour shortages while at the same time contributing to continued increases in housing rents and construction costs. In the December 2023 quarter, rents contributed 0.1% to the total 0.5% quarterly change.

High population could also put further upward pressure on local authority rates, which are contributing almost twice as much to annual CPI inflation (0.3 percentage points) as they have on average over the past 15 years.

“To sum up, monetary policy is working, with the economy slowing and inflation falling. But we still have a way to go to get inflation back to the target midpoint [of 2%],” he says.

Hawkish tone

Westpac senior economist Satish Ranchhod says the tone of Conway’s hawkish comments seem to push back on market expectations for any policy easing in the near term.

The financial markets have been pricing in an easing of the OCR and interest rates in the first half of this year. Ranchhod says this seems premature.

“When discussing the recent downside surprises to the RBNZ’s activity forecasts, Conway noted much of this was due to methodological changes related to areas like government expenditure and education. In contrast, estimates of private demand and business investment had been revised higher.

“He noted that while inflation has eased and monetary policy was working, domestic inflation remained elevated and there is still a way to go to get inflation back to the target midpoint. That focus on the midpoint is consistent with the recent change to the RBNZ remit, and also reinforces that it won’t be sufficient to just get inflation below the 3% upper bound of the RBNZ’s target range.”

He says Conway’s comments are consistent with Westpac’s forecast that any easing in policy is still some way off.

The Reserve Bank's monetary policy committee will make its next policy decision on February 28 and is widely expected to hold the OCR at 5.50%.