BNZ economists hold the “strong view” that the Reserve Bank needs to adopt a formal tightening bias when it releases its November Monetary Policy Statement on Thursday.
“It should probably back this up by moving its first published tightening forward from December 2019 to earlier in the year,” BNZ head of research Stephen Toplis says, in BNZ’s latest Markets Outlook publication.
“But while we would strongly recommend this course of action we would not be especially critical of the Bank if it, instead, hid behind the wall of confusion that currently surrounds it for a while longer.”
While economists overall are not expecting too much change from the RBNZ on Thursday under the stewardship of Acting Governor Grant Spencer, Toplis says people should not “fall into the misapprehension that Acting Governor Grant Spencer will do nothing because of the temporary nature of his role. If he, and his fellow ‘committee’ members, see reason to respond they will do so.”
Toplis says the “confusion” around the RBNZ lies with the detail of upcoming policy changes that the new government will implement.
“We all know the broad thrust of the changes but, at this stage, need a bit more detail on timing and specifics before including such change into our models. Moreover, incorporating change can take a fair few person-hours of analysis and the folk at the RBNZ really haven’t had that much time available to them.”
Toplis says though at the moment that “the rising inflation story dominates”.
“Accordingly, we think the time is ripe for the RBNZ to talk about policy normalisation in much the same way as central banks such as the Federal Reserve (which, incidentally, has an employment objective too) are doing. This is not so much an argument that interest rates NEED to rise to choke off inflation. It is more an argument that interest rates don’t need to be at emergency-low settings when inflation appears to be returning to target.
“We think there is now an air of inevitability about this transition. And we think, if pushed, the central bank will be hard pressed, at this juncture, to repeat its previous mantra that the chances of an easing are the same as the chances of a tightening. The worm, in our view, has most definitely turned. However, we do acknowledge the extremely difficult operating environment in which the RBNZ is operating and would not be completely surprised if it displayed a degree of caution in its attempt to come to grips with this transitional phase.”
‘It knows the broad thrust’
Toplis says that while the lack of detail about future government policies and changes may add to forecast confusion, the RBNZ does know the broad thrust of policy and will be keen to take a stab at its implications as soon as possible “so don’t be surprised if some effort is made to either explicitly include some policy changes or, at the least, talk of the risks of such to the Bank’s central forecasts”.
He does not buy the argument that the RBNZ would sit on its hands because it doesn’t yet know the exact detail of the future Policy Targets Agreement or, indeed the Reserve Bank Act.
“Sure, there is some uncertainty about the detail but, equally, there is a great deal of certainty too.”
Toplis says employment will enter the equation. “But if it does so, it is highly unlikely to prevent the RBNZ from becoming more hawkish as the unemployment rate looks set to sit near to, or perhaps even below, the NAIRU [non-accelerating inflation rate of unemployment].
‘This would be completely inappropriate’
“If the Reserve Bank was to stand pat until the new RBNZ Act is finalised it might have to do and say nothing for another 18 months. This would be completely inappropriate.
“CPI inflation will remain a key, probably THE key, focus of the RBNZ Act so the Bank will still want to respond to inflation developments.”
Toplis says if the RBNZ concludes that inflation is not an issue then it might well reiterate its previous statement but it won’t do this simply because of uncertainty around prospective changes to its objectives.
He says the BNZ economists expect that new Finance Minister Grant Robertson will wait for the new Governor to be installed and then sign a new Policy Targets Agreeement with an employment consideration in it in March of next year.
“In this interim way, employment would technically be a secondary objective subservient to inflation. After a full review of the RBNZ Act is completed, which is likely to take a year or so, employment is likely to be given equal status to inflation in the Act but, because there is unlikely to be a set labour market target, inflation objectives will still tend to dominate settings at the margin.”
‘It will revise inflation forecasts higher’
Toplis says while the BNZ economists have significant doubt over what the RBNZ will do with its monetary policy guidance this week, “we have little doubt it will revise its CPI inflation forecasts higher”.
“The biggest influence in this regard will be the currency. When the RBNZ put together its August MPS it assumed that the NZD TWI would average 77.9 through the December quarter of this year and 77.6 for March 2018. Its assumed value for the TWI at the September quarter 2020 end-point of its forecast track was 75.4. Right now the TWI sits at 73.6! If the RBNZ doesn’t assume the TWI will appreciate from here, which seems likely, then its current level should add around 0.5% to its year-ahead CPI forecasts taking the forecast of annual inflation to around the 2.0% mark.
“Moreover, the starting point for the Bank’s inflation forecasts is raised with September quarter CPI inflation coming in 0.3% up on the Bank’s expectations and the December quarter is looking to be equivalently above forecast. In some ways, these overshoots don’t matter much, especially if the Bank sees them as transitory but to the extent that they feed into inflation expectations and wage-setting behaviour they become more permanent in nature.”