No matter what the RBNZ does it will inevitably be the wrong thing. Not because the RBNZ is incompetent but because getting it right would require an accurate forecast of COVID’s progression, and economic impact, both here and offshore. This is simply not feasible. In reality, one of three outcomes is likely:
- We get a domestic outbreak of COVID sufficient to undermine demand and the need to raise interest rates or, at least, postpone any increase.
- COVID variants get more and more scary and impede activity globally.
- People just adapt to the new world, demand bounces aggressively, globally, while supply constraints remain elevated, resulting in a serious inflation problem across the planet. And, yet, like everyone else, the RBNZ will have to adapt a central scenario which weaves down the middle of these options. In short, then, time will either show the Bank to have been too aggressive or not aggressive enough. That’s the pleasure of being a central banker in times of excess confusion. There are some who proclaim the RBNZ should stay on the sidelines, citing the uncertainties that abound as a cause for inaction but we think this misses the point. Back in March 2020, the RBNZ slashed the cash rate to 0.25% because it was forecasting Armageddon (as were we all). We didn’t have access to the RBNZ’s full set of forecasts in March, to see just how bad it thought things would get, but we were delivered the full picture in the May Monetary Policy Statement. At that time the RBNZ was forecasting on a March 2021 basis, the following (amongst other things):
- GDP would fall an annual average 8.3%; - a 17% annual average decline in residential construction; - a 0.4% annual decline in the CPI; - an output gap of -5.6%; - a 4.1% annual decline in employment; - an unemployment rate of 7.4% for the March quarter; - an annual decline in the Labour Cost Index(LCI) of 0.2%; and - a double-digit annual drop in house prices.
Instead, this is what the March 2021 data looked like: - GDP -2.3%; - residential construction +2.0%; - CPI inflation +1.5%; - a positive output gap; - an increase in employment of 2.5%; - an unemployment rate of 4.6%; - an increase in the LCI of 1.6%; and - house price inflation of over 20%.
Currently, annual CPI inflation sits at 3.3% and core inflation (depending on the measure used) is at, or above, 2.0%. We are forecasting CPI inflation of 4.1% for the September quarter, with upside risk. Headline inflation is expected to remain above 2.0% for the foreseeable future, even with the interest rate increases we have suggested. In support of this hypothesis, inflation expectations are rising and business pricing intentions are at record highs. The unemployment rate is 4.0%, and set to fall further, which must surely be NAIRU or less. The underutilisation rate is falling. Labour market shortage indicators are at record highs and Labour Cost Index inflation is above 2.0%.
All the above says “get to neutral as fast as possible”. The RBNZ has concluded that neutral is probably somewhere of the order of 1.9%.
Taking all this into consideration, we thus reaffirm our forecast that the RBNZ raises the cash rate 25 basis points, to 0.5%, at its August meeting. We are expecting rate increases at each of the subsequent three OCR decisions. This takes the cash rate to 1.25% by February 2022. We currently forecast a peak of 2.25% by February 2023. It goes without saying that these expectations will be under constant review. If the central bank knows rates need to get back to neutral, there is some argument for a 50 basis point increase on August 18. We would not rule this out but think publishing a steady increase in rates will have the same effect and allows the Bank a bit more flexibility. If things continue to tighten, in the manner we expect, then the November meeting could get very interesting, in terms of a 50 basis point increase, given the long gap between the November and February statements. We will reassess this is in due course.
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