Reserve Bank Assistant Governor John McDermott says the measure of inflation the RBNZ pays attention to is running at about 1.4%; the 'neutral interest rate' is now down to 3.5%

By David Hargreaves

The Reserve Bank has lightly poured cold water over expectations that interest rates my be hiked as soon as next year by saying that its own ‘core’ measure sees inflation running at around just 1.4%, while it now views current interest rate levels as less ‘stimulatory’ than it previously believed.

The RBNZ now estimates the ‘neutral interest rate’, at 3.5%, from above 4% previously. As recently as two years ago, the RBNZ estimated the ‘neutral’ rate at 4.5%.

Economists saw the comments, made in a speech on Wednesday by RBNZ Assistant Governor and Head of Economics John McDermott, as indicating that the RBNZ would be in no hurry to raise interest rates.

McDermott also made reference to the high level of the New Zealand dollar (currently above US74c) and indicated that the central bank wanted to see it lower.

Essentially, by tweaking down its view of what ‘neutral’ interest rates are, the bank is saying that monetary conditions in this country are less stimulatory than the RBNZ previously thought – something major commercial bank economists have been suggesting for some time.

Additionally, a ‘core’ inflation rate of 1.4%, while within the RBNZ’s official targeted range of 1%-3% is still below the explicit target of 2%.

Official inflation figures had been outside the RBNZ  targets for a long time, but roared back within the range early this year after some sharp rises. However, these rises are being construed as largely one-off in nature.

Last week’s official inflation figures were much lower than the RBNZ had been predicting and suggested that during the course of this year the annual inflation figure will fall sharply again.

McDermott said the RBNZ’s own 1.4% estimate of ‘core’ inflation, (which excludes variable impacts such as oil price movements), “has broadly tracked sideways over the past year”.

“So while inflation pressures have lifted from the lows seen in early 2015, they still appear to be relatively moderate”

The ‘neutral’ interest rate is a theoretical, but nevertheless important figure since it guides the RBNZ’s view of whether or not current official interest rates are ‘stimulatory’ or not.

At the moment, based on a ‘neutral’ interest rate of 3.5%, this means that any Official Cash Rate set above 3.5% would be signalling tighter monetary conditions and a central bank attempting to take heat out of the economy and inflation.

Conversely, an OCR below 3.5% would be seen as stimulatory for the economy and inflation.

Our current OCR – at 1.75% is therefore ‘stimulatory’ – though not as stimulatory as if the neutral rates was assumed as say 4.5%, the level the RBNZ had it at two years ago.

McDermott indicated that the new 3.5% ‘neutral’ estimate would now be incorporated into future RBNZ projections.

Westpac senior economist Satish Ranchhod said putting this “relatively moderate inflation picture” painted by the RBNZ together with interest rates settings that aren’t as stimulatory as the central bank had previously expected, “and we’re left with an environment where the RBNZ won’t be in any rush to hike rates”.

“We’ve been noting recently that the financial market pricing for RBNZ hikes from around mid-2018 is too soon, and today’s speech reinforces that view,” he said.