MNI INTERVIEW: RBNZ Credible, Cuts Still Distant - Conway

The Reserve Bank of New Zealand’s credibility regarding its future Official Cash Rate assumptions remains intact, despite it being well out of sync with market pricing, Chief Economist Paul Conway told MNI, noting cuts were still some way off.

Pointing to five- and 10-year inflation expectations as a key measure of the Reserve’s credibility, Conway noted the New Zealand public believed the RBNZ would maintain low and stable inflation. “Over the last couple of years, five- and 10-year inflation expectations have bubbled up, but nothing that's been concerning from a credibility perspective,” he told MNI in an interview, adding that the divergence between markets and the Reserve’s OCR track is normal.

“Understanding how economies work is hard and having timely, accurate data is a challenge. There's plenty of room for people to come to different conclusions. I don't see it as a question of credibility with financial markets.”

The RBNZ’s most recently published Monetary Policy Statement increased the end-of-year OCR prediction 10bp to 5.7%, alongside the monetary policy committee’s decision to hold the rate at 5.5%. (See MNI RBNZ WATCH: MPC Cites Risk Tolerance For Restrictive OCR) Overnight index swaps markets have priced in a 5.275% OCR by November, about 25bp higher since the decision. Swaps markets have consistently priced in a lower cash rate against the RBNZ’s higher-for-longer narrative.

Conway noted the market had cause to assume impending cuts, such as the run of negative GDP data and soft business sentiment. (See MNI INTERVIEW: NZ Inflation Falling, Rate Cut Eyed - Ex RBNZ) “The labour market is starting to soften and many parts of the CPI basket are reducing,” he continued. “We're on track, but I guess there's just a different view around what needs to happen to interest rates from here to get us back to the 2% [target].”

While Q1 inflation had surprised the central bank, a faster-than-expected retracement is possible particularly for nontradeble price rises, Conway conceded.

“I do think there is a world in which nontradable inflation does start to drop away certainly more quickly than what we're seeing, but also there's a world in which it forms more quickly,” he added. The nontradable basket is labour intensive and faster-than-anticipated rising unemployment would impact the measure, he noted. “We're definitely detecting labour hoarding at the moment. Businesses have come through a period of acute labour shortages and now they're seeing less demand, so that will come to an end and it's going to help on the services side.”

OFFSHORE PEERS

Pointing to the Bank of England, Bank of Canada and the European Central Bank, Conway said any move by peer central banks to cut rates will add upward pressure on the New Zealand dollar and reduce inflationary pressure.

“That means tradables inflation falls and that would be helpful from an inflation-control perspective, which would mean that we would be more likely to cut ourselves more quickly than in a world where those other central banks don't cut. We can't get too far out of line with what's happening globally in terms of us achieving our remit."

However, he reiterated statements made in March that rate cuts were not imminent. The MPC at the recent meeting was focused on returning inflation to target with high confidence, he continued.

“We are heading back to a low-inflation environment,” he said, but stressed the Reserve had noted persistence of inflation in some parts of the economy. “That does raise concerns about near-term inflation pressures and the sooner New Zealanders start to base their economic actions and decisions on low inflation, on a low inflationary environment, then the sooner interest rates will start to fall.”

The RBNZ’s MPC will next meet July 10.