The 4 October release of the NZ roadmap out of lockdown makes the 6 October RBNZ meeting straight-forward. The RBNZ is almost certain to lift their OCR 25bps to 50bps and promise more tightening to come. Expect to see a repeat of the August message that they are confident of meeting their targets and that their ‘least regrets’ stance is for further measured reduction in the level of monetary stimulus.
No change seems slightly more likely than a 50bps hike – but the probability of each option is less than 5%. The main reason I don’t think the RBNZ will hike 50bps is because the primary purpose of RBNZ Hawkesby’s White Heron speech was to push back on market expectations for a 50bps hike.
Looking further forward, clear outlines of the case for tight monetary policy can be made out in the inflation and activity data. A more dramatic change in RBNZ forecasts may appear in November. A 50bps hike in February 2022 seems plausible, if the economy is doing well in the re-opening.
In many ways, the catalyst for the change of stance in Q3 was the Q2 CPI print. The higher-than-expected outcome put the price level above the pre-COVID baseline. This is an important point – it wasn’t catchup inflation or base effects. As of the Q2’21 inflation print the general level of prices in NZ was higher than had been forecast in the February 2020 MPS (when the OCR was 1% and projected to increase to ~2% by 2023).
While it’s true that there are some (likely) reversible price increases due to supply side problems, the fact is that tradable and non-tradable inflation are above the Feb’20 baseline. Short run inflation expectations are now above the RBNZ’s target, and the risk is that they will rise further if this period of high inflation is sustained. It’s this risk that needs to be managed.
The Q2 GDP print helped to make sense of the inflation data. The much stronger-than-expected 2.8%qoq outcome (v. RBNZ 0.7%qoq) means that the economy was operating well above potential output at that time. Similar to CPI, the level of real GDP following Q2 GDP was now clearly above the Feb’20 (pre-COVID) baseline.
The economy is running hot. As of Q2’21 GDP, the level of activity was about 3.7% higher than the RBNZ’s August MPS estimate of potential activity. Notwithstanding that better activity almost certainly means that potential output will be revised up, it’s relevant that the excess of activity over potential output is currently at a record (meaning that the economy is running hotter than ever). Even after these revisions the output gap will remain around record highs.
The main reason for caution in tightening is uncertainty about COVID. There is uncertainty both about how the economy is handling the current Delta-lockdowns, and how things will change as NZ transitions from a post-COVID expansion to an endemic-COVID recovery.
The available data suggests that things are going ok so far. The high frequency labour market data suggests that there was little job shedding during the lockdown-period in Q3. Given the tightness of the labour market (and design of COVID support measures) it’s not surprising that NZ firms held onto labour.
Where you can see the downturn is in the earnings data. This shows a clear decline due as hours were cut due to the Delta-lockdown. We are already seeing a bounce-back in earnings as the lockdown measures are eased and people return to work.
This is consistent with the gentle uptrend of mobility data in NZ.
The roadmap out of lockdown, and the resumption of normal life, depends on vaccination rate. Almost 70% of Kiwis have now had their first shot, which is higher than the US, Australia and Germany. Notwithstanding that they are still away from PM Adern’s very high aspirations, New Zealand is doing very well by international standards and the pressure to normalise both health and monetary policy will be large even if things stall in the 80s.
Once we get past the Delta shock, the case for an OCR that’s above 2% seems easy to make. The starting point in Q2 was an economy running hot. The Delta shock seems to have been modest, and high vaccination rates means that the bounce in H1’22 seems fairly secure. The FLP and stock of NZGBs on the RBNZ’s balance sheet work against the OCR, meaning that the effective OCR will be lower than the headline rate. An OCR above neutral OCR, which the RBNZ estimates to be around 2%, will be needed to get overall monetary conditions back to neutral. Given the starting point, neutral may not be sufficient.
The only thing I can see preventing an OCR above 2% in the next two years is a very strong New Zealand dollar.