MNI INTERVIEW: Rates To Hold, But Upside Risks - RBNZ's Conway

The Reserve Bank of New Zealand’s Official Cash Rate will likely hold at 5.5% well into 2024 unless data surprises force changes to projections, though short-term risks are skewed to the upside, RBNZ Chief Economist Paul Conway told MNI.

Holding the OCR steady at 5.5% for the second consecutive meeting last week, the RBNZ’s monetary policy committee was focused on the deteriorating Chinese economy, though resilient export volumes, a stabilising real-estate market and services sector price rises showed inflationary pressure persisted, Conway said. Despite these concerns, the Reserve’s rate track remained flat out to mid-2024, he noted.

“It's important to get that across that we are still very much in the ‘watch, worry and wait’ mode,” he told MNI. “Interest rates could go down, as well as up, when it moves next and our baseline scenario is that that move will be some time next year. If we get there, and if inflation continues to fall, then that's a pretty good outcome, but it likely won't require tweaks to the current rate track."

The Reserve also revised up its estimate of the nominal neutral Official Cash Rate 25bp to 2.25%, meaning that it considers rates need to be higher than previous thought to constrain prices, and pushed out the profile of the OCR’s projected path. The overnight index swap market has priced in a slight chance of a hike at the Reserve’s Nov 29 meeting. (See MNI RBNZ WATCH: OCR Path Rethink As Core Inflation High)

Markets should refrain from reading too much into the updated nominal neutral OCR, Conway said, stressing that the MPC will focus on how the economy tracks against the Reserve’s projections in its coming decisions. GDP fell 0.1% over Q2 and the MPC would want to see further low, or zero, growth, he added.

PERSISTENT INFLATION

Persistent price increases still risk feeding expectations, presenting an upside OCR risk in the short-term, he said, pointing to factors likely driving stubborn services inflation in particular, such as wage increases outstripping productivity, as well as some administrative processes, including council rate rises and an increase to excise tax.

“The bank will look through that though, as it’s happening in the short run… but if it feeds into people's expectations, wage demands and inflation stays persistent,” he said, noting data showed inflation expectations in general had reduced.

“Over the medium term, we're looking very carefully at the global economy, particularly at China, given that it's such an important destination for New Zealand exports,” Conway continued. He stressed, however, that the New Zealand economy was slowing in line with expectations. “The interest-rate sensitive parts of the economy show good evidence that demand is falling,” he added.

Tourism and migration are also both recovering and RBNZ officials are debating whether the increased flow is inflationary, he said. “Traditionally, we've treated migration as being mildly inflationary, however, in the context of a very strong labor market it may well be the case that it is having a positive effect on supply relative to demand more so than in the past."

The RBNZ is working to understand the changed dynamics of New Zealand’s post-Covid economy, he said.

“We are re-testing some of that conventional wisdom about how the economy operates,” he commented.