By Bernard Hickey
Finance Minister Bill English said he was concerned about the rise in the New Zealand dollar on Tuesday to a 14-month high of over 77 on the Trade Weighted Index, but said that the Reserve Bank appeared unlikely to be able to do much about it because the traditional linkages between the Official Cash Rate and the currency had broken down.
English told reporters in Parliament that observers should not be too hard on the Reserve Bank over its failure to meet its inflation targets, given what was happening in the rest of the world.
The comments appear to give the Reserve Bank a free pass to ignore the currency’s rise, which the bank itself said in its June Monetary Policy Statement was too high and would force rate cuts to 0.75% over the next couple of years if it stayed up at early June levels of 72.6 on the TWI. The Reserve Bank included a ‘high TWI’ scenario that, all other things being equal, would create deflationary pressures that would force the Reserve Bank to cut the OCR from 2.25% to 0.75% by early 2018.
English is responsible for holding Reserve Bank Governor Graeme Wheeler to account over the Policy Targets Agreement, which states the bank should “keep future CPI inflation outcomes between 1-3% on average over the medium term, with a focus on keeping future average inflation near the 2%.”
Annual CPI Inflation was 0.4% in the March quarter. It has been below 1% since the September quarter of 2014 and below 2% since the September quarter of 2011. The Reserve Bank’s forecasts in the June Monetary Policy Statement showed CPI inflation would not return to 2% until the December quarter of 2017, which would mean inflation had been below the Governor’s 2% mid-point for six years.
Asked if the high currency was a concern, English said: “Yes, but it’s an indicator of the amount of uncertainty in the rest of the world. As the Reserve Bank Governor pointed out, the traditional linkage between interest rates and the exchange rate doesn’t appear to be holding at the moment.”
“He’s cut interest rates quite a lot in the last 18 months and the exchange has actually gone up and you would not have expected that to happen. When you look around the world and see Sterling falling, the US dollar probably softer than we might have expected, uncertainty about Italian banking issues building up inside the European Union, bit of political uncertainty in Australia, you can see why relatively speaking New Zealand’s currency looks for now a bit more reliable than most,” English said.
Aren’t more even more OCR cuts needed?
Asked if Wheeler should therefore be cutting the OCR by even more, he said: “You’d need to talk to the Governor. He was pointing out that cutting interest rates didn’t seem to have affected the currency. We are in a pretty strange economic world. The Swiss or Japanese Government is issuing 20 year bonds on negative interest rates. No one really knows what that means or what all the implications of that are. It’s a bit hard to draw simple conclusions from a movement in interest rates or a movement in currency rates.”
English was then asked if the economy and exporters should therefore just have to sit there and take the higher currency, he said: “It’s a rate set by the market. There’s a lot of dangers in trying to use your Reserve Bank to play around with the exchange rates, particularly in a world where no one really quite understands how different economic indices are going to interact. Normally you would expect a flow through from currency connections to inflation and interest rates, and that’s part of the very difficult task that the Reserve Bank has.”
“The relationships which in the past which we assumed were quite mechanical, now just don’t seem to hold. I’m sure if it was easy then they would have easily hit the target. One of the challenges for this central bank and others is that any given day you can’t really judge what the right decisions is. You can only really judge in hindsight so they’ve got a real dilemma.”
Most economists expect the Reserve Bank to cut its OCR again on August 11, with the potential for one more cut to 1.75%, partly because of the very high TWI.
When do you hold the RBNZ accountable?
English was then asked when he would hold the Reserve Bank accountable for not meeting its inflation targets.
“You’ve got to keep in mind a wider context. They’re dealing with a world where it’s been pulling towards 0% interest rates and they’re trying to get ours up, and that’s a real challenge. In the light of the very complex economic environment we’re in, we shouldn’t be too hard on them,” he said.