RBNZ in ‘Central Bank Nirvana' Even as Inflation Undershoots

Updated on
  • Assistant Governor McDermott says CPI volatility is ‘noise’
  • Anchored inflation expectations warrant neutral rates stance
John McDermott Photographer: Mark Coote/Bloomberg

New Zealand’s central bank is content to persist with a neutral stance on interest rates because consumers and businesses still expect currently weak inflation to return to 2 percent, Assistant Governor John McDermott said.

“That’s central bank nirvana,” McDermott said in an interview in Wellington Thursday after the Reserve Bank held its benchmark rate at 1.75 percent, a record low. Recent surprisingly weak headline inflation “is not something that should move policy around unless it starts to move inflation expectations,” he said.

Read more about RBNZ’s rate decision and updated forecasts here

The RBNZ today cut its inflation forecasts and predicted it won’t reach the 2-percent midpoint of its 1-3 percent target range until late 2020, more than two years later than previously expected. Despite that, it maintained its projection that the official cash rate will remain on hold this year and start to rise in mid-2019.

Two-year ahead inflation expectations were at 2.02 percent in the fourth quarter, according to a survey of businesses published by the central bank in November. The next reading is due on Feb. 14.

Kiwi Weakens

The New Zealand dollar fell a quarter of a U.S. cent on McDermott’s comments, extending its loss since Thursday morning’s rate decision to more than half a cent. It traded at 72.05 cents at 2:08 p.m. in Wellington.

McDermott said the bank’s stance on rates is “neutral.”

“There is a significant probability that the next rate move could be an increase sometime in the future, and there’s also a substantial probability that the next move could actually be a cut,” he said. “If we saw big moves in inflation expectations, the market should expect the bank to act.”

Hike Less Likely

While economists and investors don’t expect the RBNZ to cut rates, they have progressively downgraded the likelihood of a rate increase this year. There’s a 52 percent chance of a hike in November, down from 100 percent three months ago, according to swaps data compiled by Bloomberg.

The RBNZ today forecast that inflation will slow to 1.1 percent this quarter from 1.6 percent last quarter. The headline rate has only reached 2 percent in one quarter during the last six years. The bank’s new projections show it returning to 2 percent in the third quarter of 2020, rather than in the second quarter of this year.

McDermott described recent volatility in headline inflation as “noise” driven largely by the impact of a strong New Zealand dollar on import prices. The bank chooses to “look through it, because that’s not a good indicator of where real, core inflation is,” he said.

Core inflation is currently running at 1.4 percent and McDermott said “indicators are it will gradually move up.”

He said the labor market has tightened and on balance should start to generate price pressures in time, though at present it was “not putting undue pressure on inflation.”

The New Zealand dollar should also ease as the U.S. Federal Reserve raises rates and the rate differential with the RBNZ closes, he said.

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