As was widely expected (and priced) the RBNZ hiked their OCR 25bps to 50bps at their 6 October meeting. They indicated that there’s more tightening to come, noting rising capacity pressures and the need to reduce monetary policy stimulus to maintain price stability.
The Committee agreed that rising capacity pressures would feed through into inflation. Employment is expected to remain at around its maximum sustainable level. Members concluded that monetary policy stimulus will need to be reduced to maintain price stability and maximum sustainable employment over the medium term.
The Committee agreed to further reduce the level of monetary stimulus at this meeting by increasing the Official Cash Rate (OCR) to 0.5 percent. The Committee noted that further removal of monetary policy stimulus is expected over time, with future moves contingent on the medium-term outlook for inflation and employment.RBNZ, 6 October 2021, Summary Record of Meeting (my emphasis)
The most important part of the communication was the assertion that the Delta outbreak hasn’t changed the outlook and that the economy will recover quickly once restriction have eased. So, there’s no sign of the RBNZ getting cold feet on tightening due to the most recent COVID outbreak.
The current COVID-19-related restrictions have not materially changed the medium-term outlook for inflation and employment since the August Statement. Capacity pressures remain evident in the economy, particularly in the labour market. A broad range of economic indicators highlight that the New Zealand economy has been performing strongly in aggregate.RBNZ, 6 October 2021, post-meeting statement (my emphasis).
This is helpful, as it means we can use the OCR-track in the August MPS as a guide to the policy outlook. The OCR-track in the August MPS had been adjusted for the decision to hold in August. It contained three consecutive 25bps hikes (October, November and February). Consistent with their assertion that Delta didn’t change the outlook, the first of those hikes was delivered today.
Of course, the remaining hikes are conditional on the inflation and employment outlook. The RBNZ noted that the employment outlook remain firm: this is consistent with the weekly employment data, and confirmed by the NZIER’s Q3 QSBO. Once we get past the Delta-shock, the outlook is for a strong labour market and a bit more inflation than the RBNZ forecast in August.
The GDP data since the RBNZ produced these forecasts has been stronger than they expected, and the output gap is a bit more +ve, so the inflation forecast ought to be revised up a bit. In particular, the Q2 GDP print was much stronger than the RBNZ expected (see my October RBNZ preview for more on this). The higher than expected level of activity in Q2’21 pushed the level of output above the pre-COVID (Feb’20 MPS) baseline, and the output gap to a record +ve (though it should be noted that potential output will be revised up a bit). Again, the NZIER’s Q3 QSBO confirms this signal, showing that capacity pressures remain acute.
A better starting point, the absence of job shedding due to Delta, and ongoing signs of acute capacity constraints all point to the risk of more inflation as the NZ Economy re-opens. I don’t make much of the apparent decline of price intentions in the Q3 QSBO — lots of firms put up prices in Q2 and are likely waiting to see how things pan out before they raise them once again. A tight labour market and binding capacity constraints make more price hikes very likely.
Taken together, there is a case for a more hawkish OCR track than the RBNZ had in their August MPS.
The RBNZ seemed to go some way in that direction today, noting the risk that the present ‘relative price shocks’ lead to ‘more generalised price rises’. That’s code for concern that currently high inflation will lead to a further increase in inflation expectations and hence sustained higher inflation. They’d be worried that a tight labour market and capacity constraints would interact with rising short-term inflation expectations to lead to more persistent wage-price pressures.
Headline CPI inflation is expected to increase above 4 percent in the near term before returning towards the 2 percent midpoint over the medium term. The near-term rise in inflation is accentuated by higher oil prices, rising transport costs and the impact of supply shortfalls. These immediate relative price shocks risk leading to more generalised price rises. At this time, measures of core inflation and medium-term inflation expectations remain close to 2 percent.RBNZ, 6 October 2021, post-meeting statement (my emphasis).
The RBNZ’s thinking about COVID seems to have changed. They are now much more concerned about the supply-side / inflation consequences of COVID.
With regard to the stance of monetary policy, the Committee noted that the current restrictions are creating a different set of policy challenges than in 2020. Demand shortfalls are less of an issue than the economy hitting capacity constraints given the effectiveness of Government support and resilience of household and business balance sheets. While some capacity bottlenecks are likely to be short term, there is a risk that these become more persistent as we transition to a COVID-19 endemic state of the world.RBNZ, 6 October 2021, Summary Record of Meeting (my emphasis)
The urgency to tighten logically follows. The RBNZ estimates that neutral is around 2% — however a 2% OCR won’t get overall monetary conditions back to neutral in 2023, as their stock of NZGBs and the FLP will lower the effective OCR.
With that in mind, I’ve got the RBNZ tightening 25bps per meeting to 2% in Aug’22, and then adding another 50bps in H1’23, to peak at 2.5% in H1’23.
Forecasts that far out aren’t worth much: my key message is that things were a bit more inflationary than the RBNZ expected in August, and that the lingering effects of prior unconventional policy easing means they’ll need to get the OCR above their estimate of neutral to return overall monetary conditions to neutral.
The main thing that could stop this developing is a much stronger NZD.