The unemployment rate is high and consumer demand is weak, factors even the RBNZ concedes will limit the pass-through of oil shock inflation to the wider economy.
In fact, the RBNZ lowered its inflation forecasts. It now expects the peak of oil shock inflation (in the second quarter) to be 3.9% instead of the 4.2% it forecast in May.
That’s still too high and well outside the RBNZ’s mandated target of 1-3%.
The RBNZ has the capacity to look through that supply shock spike in the short term.
But the Monetary Policy Committee was clear about the uncertainty and inflation risk it sees in the medium term.
“Spare capacity in the economy is expected to limit firms’ ability to pass on higher costs, meaning many businesses may need to absorb them in margins,” the committee said.
“However, some firms may look to rebuild margins as demand recovers. If sustained, a lower exchange rate could also add to medium-term inflation pressures.”
Challenged about the need to hike now – with the labour market still so weak – Reserve Bank Governor Anna Breman emphasised the impact inflation had on growth.
“High inflation, as we’ve had now for some time, erodes household purchasing power,” she said.
“So for households to feel like they can consume again and invest, we need to get inflation back.
“From our perspective, inflation is also hurting growth, and we need to get inflation back down to be able to also see stronger growth and a stronger labour market going forward.”
The Reserve Bank now has a single mandate to target inflation, as opposed to the previous dual mandate, which included unemployment.
Breman acknowledged there was still a great deal of uncertainty about the immediate outlook – not least because of the ongoing volatility in the Middle East.
But the message was clear, the journey back to a neutral rate has begun.
The RBNZ considers neutral to be somewhere between 2.75% and 3.35%. Possibly skewing higher if fuel prices stay elevated.
While the timing and final endpoint may still be undetermined, the path forward is not.
As Infometrics chief forecaster Gareth Kiernan points out, rising rates are on the cards regardless of whether they are underpinned by higher external inflation or, preferably, by stronger domestic growth.
“The need for less stimulatory monetary conditions is true, whether the bank is pushing against second-round prices from the recent fuel price shock, or removing stimulus from the economy as growth gets set to recover in the coming quarters,” he said.
To some extent, the move to a higher OCR reflects optimism from the RBNZ that the economic recovery will get back on track quickly.
It forecasts a return to economic growth in the (current) September quarter and an acceleration of the recovery from there.
The language of the RBNZ didn’t suggest urgency, said ANZ’s Zollner.
ANZ chief economist Sharon Zollner says rising rates may be a symptom of a recovering economy. Photo / Corey Fleming
That was “consistent with our view that a dovish-to-neutral hike with little forward guidance would provide the most flexibility in a world where the data is set to remain mixed and the outlook is uncertain”, she said.
But reading between the RBNZ’s lines, Zollner took some heart from the beginning of the end for stimulatory policy.
“We are optimistic that the economy will get back on track before long,” she said.
“While our OCR forecast of three hikes in quick succession is unchanged since the peak of the oil price shock, the underlying story is now a much more cheerful one.”
Zollner said she thought the RBNZ would continue to hike the OCR simply because the economy doesn’t need stimulatory monetary policy any more.
“That’s a lot more palatable than the previous scenario, of the RBNZ having to hike despite a weak economy because of an external cost shock that demands extra short-term pain to achieve the long-term gain of low and stable inflation.”
Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003.
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