MNI INTERVIEW: More OCR Hikes Possible - Ex-RBNZ Governor

Persistently strong employment may force the Reserve Bank of New Zealand to raise the Official Cash Rate further despite its signaling to the contrary, a former RBNZ governor told MNI.

While Don Brash, governor between 1988-2002, said the monetary policy committee (MPC) would rather avoid further rate hikes ahead of the Oct. 14 general election, he saw more tightening as being likely.

“I think 3.6% unemployment currently is a pretty low level and labour demand is still very high," Brash noted. "Wage settlements, particularly the public sector, are inconsistent with a 1-3% inflation target.”

Stats NZ data this week showed the unemployment rate rose 20bp to 3.6% q/q in Q2 – 0.1pp above the RBNZ’s forecast, though salary and wage rates climbed 4.3% y/y. The employment rate also gained 1.25% y/y to 69.8% and added 0.3% over the quarter, while labour force participation grew 1.5% over the year, or 0.4% q/q, to 72.4%.

The central bank aligned with market expectations in July, holding the cash rate steady at 5.5%, noting rates were now restrictive. (See MNI RBNZ WATCH: Rates Rest At Restrictive Level) Some ex-RBNZ staffers, however, have told MNI sticky services inflation could thwart the Reserve’s peak-rate call, while the overnight index swap market has priced in a small chance of a hike at the Nov. 29 meeting.

In making his call for more tightening, Brash conceded he was not as informed as the RBNZ and noted that the economy faces headwinds such as an “enormously high” current account and fiscal deficit, which were both unsustainable. China’s slowdown will also negatively impact exports, he added.

The MPC will next meet Aug. 16 and again on Oct. 4.

INFLATION TARGETING

During his tenor, Brash ushered in sweeping reforms at the RBNZ, setting it on a path towards independence and helping develop the inflation targeting model since adopted by other central banks. Brash said inflation targeting – initially launched with a 0-2% band – was a success, holding the central bank to account and conditioning market and public inflation expectations.

“Clearly, in the last year or two, we've broken out of the [1-3%] inflation target by quite a significant amount, as indeed many other countries have," Brash said. "The Governor [Adrian Orr] will be the first to admit he misread the situation, as indeed so many other central bank governors did.”

Calls to increase targets in light of recent high inflation, however, were misguided, Brash argued, noting that a 4% upper limit would result in prices doubling every 16-18 years. "That's a rapid doubling of prices, so I don't favour a higher rate," he added. A change to the target would also signal to the public that the Reserve would simply "move the goalposts" every time inflation increased too rapidly, with undesirable effects on behaviour and expectations.

Brash opposes the adoption of dual mandates which supplement inflation objectives with targets for employment, such as the one given to the RBNZ by the current Labour Government in 2018. Monetary-policy is ill-equipped to manage employment targets, particularly if inflation rises faster than joblessness, he noted.

"If inflation starts getting away, and unemployment is higher, there’s a conflict and you have to decide which of those two objectives has primacy – so the single target makes much more sense," he said.

The opposition National Party has vowed to repeal the RBNZ’s dual mandate should it win government, among other reforms. Brash was a National Party politician and member of the House of Representatives between 2002-2007. He led the opposition from 2003, but lost to the Labour Party at the 2005 election.