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REPEAT: MNI INSIGHT: Weakening NZD-Infla Link Worries RBNZ

MNI (London)
Repeats Story Initially Transmitted at 22:10 GMT May 23/18:10 EST May 23
--RBNZ No Longer Confident Lower NZD Will Boost Tradables CPI
By Sophia Rodrigues
     SYDNEY (MNI) - The Reserve Bank of New Zealand is doing some hard thinking
on the strength of any pass-through from exchange rate depreciation to
inflation, with the recent debate in the UK a reminder to small open economies
like New Zealand to keep the issue in review, MNI understands.
     This is a reason why the RBNZ's latest Monetary Policy Statement didn't
have much discussion on the New Zealand dollar's depreciation. Significantly,
there was no discussion of a scenario where the trade-weighted exchange rate
could depreciate because of higher global inflation and faster tightening in
global monetary policy, which could lead to higher import prices, thus requiring
a rise in the Official cash rate.
     In fact, throughout the entire MPS, the RBNZ appeared to have downplayed
the depreciation of the New Zealand dollar and the possibility of further
     The RBNZ merely said that it assumes the NZD trade-weighted index (TWI)
will depreciate very gradually over the projection. "As imports become more
expensive in New Zealand dollar terms, this adds slightly to tradables inflation
over the projection."
     On the other hand, the RBNZ focused on a scenario where the OCR could be
cut even as the exchange rate depreciates. This is one of the two risk scenarios
discussed in the May MPS, with the other being one where OCR could be raised if
price-setting behaviour by businesses becomes more forward-looking.
     The RBNZ said if global financial conditions were to tighten abruptly, it
would reduce world demand and lower the price of New Zealand's exports. This
could push up long-term interest rates and lead to higher funding costs for New
Zealand banks and, ergo, higher mortgage rates. 
     "While the New Zealand dollar TWI would depreciate, the increase in
mortgage rates and lower export prices would dampen consumption and business
investment. In this scenario, the Bank would need to lower the OCR to support
the economy and meet its inflation and employment objectives," the RBNZ said.
     The RBNZ is taking lessons from developments in the UK, where the Bank of
England recently said that the impact of the past depreciation of sterling on
CPI inflation, while remaining significant, is likely to fade a little faster
than previously thought. 
     Specifically, the Bank of England has assessed that the pass-through of
lower sterling value to import prices has been less than it previously expected.
     It's interesting to note how the RBNZ's language on the exchange rate has
evolved in the last nine months.
     Until August last year, the central bank said a lower New Zealand dollar is
needed to increase tradables inflation and help deliver more balanced growth. By
November, the exchange rate had depreciated and the RBNZ said if the decline
sustains, it would increase tradables inflation and promote more balanced
     In February, the RBNZ didn't make any direct mention of the exchange rate
but said that the fall in the second half of 2017 and the rise in oil prices
would support tradables inflation.
     "The TWI remains lower than the level observed in mid-2017 and is expected
to support tradables inflation in 2018," the RBNZ said.
     Until then, the RBNZ was fairly confident that a lower exchange rate would
boost tradable inflation, and help inflation progressing towards the target
     However, the RBNZ's hopes were dashed in the Q1 consumer price index data,
which showed tradable inflation fell 0.4% y/y compared with their forecast for a
flat outcome. The data reminded the RBNZ that the exchange rate-inflation
relationship is weakening.
     That is why despite a lower starting point for the NZD TWI and a lower
forecast path in the May MPS compared with February, the RBNZ lowered the
forecast for tradable inflation instead of raising it.
     For Q2, the RBNZ is forecasting tradable inflation to rise 0.4% y/y versus
0.9% forecast in February. For Q3 and Q4 the RBNZ is forecasting 0.8% and 0.5%
rise versus 1.1% forecast in February for both Q3 and Q4.
--MNI Sydney Bureau; tel: +61 2-9716-5467; email:
--MNI London Bureau; tel: +44 203-586-2225; email:
MNI London Bureau | +44 203-865-3812 |
MNI London Bureau | +44 203-865-3812 |

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