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RBNZ speech makes the case for gradual adjustments - Westpac

Satish Ranchhod, Senior Economist at Westpac, points out that this afternoon Acting RBNZ Governor Grant Spencer delivered a speech entitled “Monetary policy grapples with drivers of weak inflation” and the speech detailed some of the reasons that inflation has lingered below the 2% mid-point of the RBNZ’s target band in recent years.

Key Quotes

“The RBNZ also used today’s speech to explain how and why they have responded to this soft inflation environment in the way they have. The RBNZ (like central banks globally) has been wrestling with a range of factors that have kept inflation low. Many of these factors are related to imported inflation and have been more persistent than expected.”

“Despite the current softness in inflation, the RBNZ expects that both domestic and imported inflation will pick up over the coming years. And with this in mind, they are mindful that trying to boost inflation now could cause unnecessary instability in other economic outputs down the line. It could also affect household debt. Consequently, the RBNZ believes it’s appropriate to keep rates low for some time yet, but isn’t looking to cut rates anytime soon.”

“Essentially, the RBNZ is aiming to gradually increase the rate of inflation. This aims to avoid an overshoot that would require higher interest rates, which would likely be negative for growth and employment in the longer term.”

“What makes this interesting is the political backdrop. The new Government has stated that it wants to move the RBNZ to a dual mandate, adding a focus on maximising employment, as well as price stability. However, the Governor today noted that: “there remains broad confidence in the effectiveness of the current framework. We should therefore be cautious about making any recommendations for change.” He went on to note that the RBNZ’s current approach is “consistent with the Government’s initiative to introduce a dual mandate for monetary policy.”

“We doubt the new Government shares this interpretation. When unemployment is higher than normal, the RBNZ’s approach implies a gradual decline to avoid the risk of an overshoot. However, the Government’s intended ‘maximum employment’ mandate would argue for a rapid reduction in unemployment in these circumstances.”

“This may not have much bearing on what happens with monetary policy over the next few months. However, The Finance Minister has indicated that he wants the next Governor, who’ll step into the ring after the March OCR review, to place greater weight on labour market conditions, with the aim of supporting employment growth.”

“A key concern with a ‘maximum employment’ goal is that it’s not symmetric. If the employment mandate caused the RBNZ to become quicker to cut interest rates and slower to raise them, the consequence would be higher inflation over time. That could actually be detrimental for growth over an extended period.”

“There wasn’t a lot of new information here for financial markets, with the speech really fleshing out the thinking behind the November Monetary Policy Statement. The speech highlighted both upside risks for inflation (mainly on the import side) and downside ones (relating to how quickly domestic activity increases).”

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