The Reserve Bank faces a hazardous high-wire act.
The Reserve Bank of New Zealand faces one of its most difficult interest rate decisions on Wednesday. Should it hold fire to give the bruised economy a better chance at recovery? Or take a shot to stop inflation getting a headstart?
These policymakers were split down the middle at their May meeting. Half wanted to hike the Official Cash Rate that month and the other half wanted to hold, leaving the new Governor, Swedish-born Anna Breman, to break the tie on her second vote in the job.
She decided to hold. It was a gutsy decision with inflation already above target and forecast to rise to 4% in the coming months. After the pandemic, central bankers spent several months believing inflation was “transitory” and then spent several years trying to correct that mistake.
Setting interest rates is a mundane pastime during the best of times but it becomes a hazardous high-wire act in more difficult moments.
On one hand, oil prices have fallen dramatically now that the US war in Iran is over-ish and the Strait of Hormuz is open-ish. That should ease pricing pressure across the economy. But on the other hand, people’s expectation of inflation over the next year has risen to 3.4%, the highest it has been since 2023.
And so, economists are again divided over what the RBNZ’s next move should be. A majority expect the RBNZ to increase the OCR to 2.5% but a solid minority think the bank should hold at 2.25% instead.
Jarrod Kerr, the chief economist at Kiwibank, is the loudest voice in the latter camp. He says high fuel prices were only a temporary problem and any lingering impact on other prices should pass quickly. “Interest rates should be held to allow the economy to recover. There’s no need to jump at shadows,” he wrote in NZIER’s Monetary Policy Shadow Board media release.
BNZ’s head of research, Stephen Toplis takes the other side of the debate. He says the central bank cannot be adding inflationary pressure when prices are already rising too quickly. “Interest rates need to be raised towards neutral as soon as possible. Only when neutrality is achieved should it contemplate pausing,” he said, in the same media release.
The neutral OCR is a theoretical interest rate that would neither support nor slow the economy. It is currently estimated to be about 3% but nobody knows exactly.
In simple terms, one group thinks the central bank should keep its foot on the accelerator while the other thinks it should lift off the pedal without actually touching the brakes. Everyone agrees the economy is not running as fast as it should; they differ only on how hot to let the engine run while it gets back up to speed.
Internationally, the consensus is that the war in Iran will mean interest rates need to be higher for the next few years. Bloomberg Economics says it expects central bank rates across the world will be half a percentage point higher than in forecasts from before the US war in Iran.
The International Monetary Fund recently advised the RBNZ to lift interest rates to a neutral position so that it can respond quickly if inflation does prove persistent. Essentially saying: don’t repeat your pandemic mistake.
In a recent commentary note, ASB economist Wesley Tanuvasa said former Governor Adrian Orr described making policy decisions in uncertain times as being like “jumping at a crocodile in a dimly lit room”.
He meant it as a word of caution: Jump to the wrong place and you might get your leg bitten off. But then again, you do not want to leave a hungry crocodile roaming a dark room for too long.
And so, even if the central bank decides to hold rates on Wednesday, it will likely warn that it plans to tighten its policy in the future.
RBNZ chief economist Paul Conway will give a speech next week about whether higher oil prices will push inflation up, and whether recent price rises have changed what people think inflation will do next. We won’t know his conclusion until he gives the speech, but the wording sounds a lot like the central bank is preparing to explain why interest rates need to rise.
