The Reserve Bank (RBNZ) says it is unlikely any decision on the 'neutral' level for the Official Cash Rate (OCR) will be made this year.
When announcing a fourth consecutive 50 basis-point hike for the OCR last week the RBNZ said its Monetary Policy Committee had discussed the possibility that neutral interest rates may now be higher.
"For example, market-based estimates of neutral nominal interest rates have increased over the past year. Staff will be undertaking further work to review their estimates," the RBNZ said.
The current 'neutral' level of the OCR is thought to be around 2%. While unobservable as such, the concept of 'neutral' interest rates is important because it describes rates that are neither stimulatory for the economy, nor restrictive. Neither too hot nor too cold if you like.
Our OCR has therefore been moved in the past year from highly stimulatory (at just 0.25% till October 2021) to a now restrictive 3.0%.
Any changes that the RBNZ therefore makes to its perception of where 'neutral' sits have a direct impact on where it thinks the OCR should be at any given time. All things being equal, if the RBNZ now increases its view of where 'neutral' is, this should theoretically affect where it thinks the OCR should be raised to during this current hiking cycle.
At the moment the central bank has a 'forward track' forecast for the OCR that sees it peaking at just over 4% by the middle of next year.
Theoretically a change to the 'neutral' rate, making it higher, might suggest that the RBNZ would have to increase the OCR to somewhat higher than that current peak to achieve the desired restrictive levels to control inflation - last seen at an annual rate of 7.3% as of the June quarter.
The wholesale interest rate markets are currently just about pricing in a 4% OCR by the end of this year - and are now leaning towards an OCR peak of 4.25% by the middle of 2023.
News agency Bloomberg quoted RBNZ Deputy Governor Christian Hawkesby this week as saying there was a risk of the OCR climbing to 4.25%. Hawkesby said the RBNZ had “talked about a range of 2% to 3%” for the neutral OCR.
RBNZ Assistant Governor/General Manager Economics, Financial Markets and Banking Karen Silk told me that the bank had “discussed the fact that there are some market estimates out there that neutral nominal interest rates have increased over the past year".
“Reviewing that is an extensive piece of work, so, something that’s highly unlikely to be completed in this calendar year. But it is certainly being added to the agenda of work for the Reserve Bank to do.
“Any assessment of neutral rates is largely a historic one and at the time you do them they are obviously surrounded by reasonably high levels of uncertainty. And that really reflects that economics is an art it is not a science. The assessment of a neutral OCR whether it is two, two and a quarter, two and a half won’t make a material difference right now.
“We believe we have the OCR pitched into the more restrictive territory and we can see that it is slowing consumer credit growth and business investment and this indicates that current financial settings are restrictive and are starting to have an impact on demand and at least credit.
"So, we’ve got time to do that piece of work to understand whether neutral rates are actually higher than the historic assessment that we’ve had around where neutral rates sit. Its level of importance in terms of making the decisions that we need to make today is lower. It is however something we need to think about particularly as you get to the point where you are starting to see the turn in the cycle."
Silk, formerly a general manager with Westpac New Zealand, joined the RBNZ earlier this year and as a member of the RBNZ's Monetary Policy Committee (MPC) she's now sat in on three OCR reviews.
The MPC itself is still a relatively new thing, having been established in 2019 and changing the OCR decision-making process from one in which it was a decision make by the RBNZ Governor, to one made by the committee.
Silk said she has found the MPC process "very considered and inclusive" and "I think it has got a really strong learning bias built into it".
“I think what most people don’t actually understand is that the process is a 10-day process. It is not a quick two-hour meeting to decide whether we think things should move in one direction or another. Within the Reserve Bank there are multiple teams that are working for weeks before hand to prepare information for the Monetary Policy Committee to consider in its evaluation.
“It is a period of deliberation, discussion, reflection, risk assessment, and as I say it is very well considered and the decision is one where people don’t go in with predetermined outcomes it is a decision that is made on the final day in terms of confirming that this is the decision that we want to make. It is a very well considered process.
“The learning bias is something that really stands out for me. It shows up in a number of ways. It shows up in the degree of interest that exists in terms of understanding what high frequency indicators are saying alongside hard data. A lot of reflection on what has occurred versus what was expected at the time of prior decisions and what we can take from that when we are thinking about the current process and decision making and then a lot of looking forward at what are the areas of most concern that might want to delve into more deeply.
“So, when we finish on that Wednesday, the teams are picking up the pens on the Thursday to really start digging into the areas that the MPC want to know more about and as we are thinking into the future around where things may head from here."
She concedes the OCR decisions might get harder next year as the RBNZ approaches the peak of this current hiking cycle and has to decide how much is enough.
“Yes, I think it will get trickier, particularly as you are trying to interpret forward looking indicators at the same time as hard data. Collecting as much hard data as you can along the way.
“In hindsight it is always easy to pick when the turn was. When you are in the moment it is an awful lot harder to do. But the committee is well versed in having the need to make decisions and there is a need to make decisions based on the information that you have at hand at the point in time but acknowledging where future risks may lie."
31 Comments
So if the negative OCR signaling is anything to go by, we can probably count on rates dropping from now on.
Pretty miserable picture for mortgage holders: A longer, higher interest rate cycle, inflation to match and heaven forbid you even think of asking for a pay increase offset the damage to your actual income in real terms.
If I were the RBNZ, I would be keeping a very low profile. What's the mark to market loss on the LSAP portfolio Karen? $8.5b? Just imagine what that could be used for now, imagine what our health system would look like, infrastructure projects etc.
The RBNZ do not determine the neutral interest rate for what it's worth, but she knows that.
From above
At the moment the central bank has a 'forward track' forecast for the OCR that sees it peaking at just over 4% by the middle of next year.
Here is RBNZ inflation expectation in 2021
However, high inflation is expected to be temporary. While inflation is expected to increase further over the rest of the year as these conditions persist, annual inflation is expected to ease towards our 2% target midpoint in 2022. Expectations for inflation in two or more years’ time remain anchored near 2%.
Marks out of 10 for accuracy?
Conclusion - when making financial decisions like buying a house, choosing a mortgage, superannuation investments whatever. Ignore what the guys in charge say and use common sense and balanced viewpoints. This lot are better saying nothing about the future.
"Any assessment of neutral rates is largely a historic one and at the time you do them they are obviously surrounded by reasonably high levels of uncertainty. And that really reflects that economics is an art it is not a science"
At this point we might as well elect an RBNZ board of lay persons using the same criteria we use for jury duty.
Or have we replaced medical expertise with politicalisation and profiteering by big pharma?
the most stark example
remember when the medical experts said the jab would prevent infection? pandemic of the unvaccinated? safe and effective? 14 days to flatten the curve? masks don't work?
This pandemic has proven that we should all be very skeptical of the so called experts. The weather reports are more accurate!
r*. "A certain rate of interest on loans which is neutral in respect to commodity prices and tends neither to raise nor to lower them"
This is not new stuff ( eg: Wicksell 1890's), and yet here we are; facing Central Bank failure to police what has been discussed for 100 years or more. To suggest 'we have got it terribly wrong' at the moment is an understatement. Fixing it is going to be a painful trick worth watching.
[The natural rate] is never high or low in itself, but only in relation to the profit which people can make with the money in their hands, and this, of course, varies. In good times, when trade is brisk, the rate of profit is high, and, what is of great consequence, is generally expected to remain high; in periods of depression it is low, and expected to remain low.
When nominal profits are expected to be robust, holders of money must be compensated for lending it out by higher interest rates. Thus, the same holds for inflationary circumstances, where nominal profits follow the rate of consumer prices. During the Great Inflation, interest rates weren’t low at all, they were through the roof well into double digits and higher by 1980. At the opposite end in the Great Depression, interest rates were low and stayed there because, as Wicksell wrote, the rate of profit was low and was expected to be low well into the future. High quality borrowers were given as much money as they could want while the rest of the economy was deprived of funds; liquidity and safety being the only preferences in what sounds entirely familiar. Link
R* [neutral rate] is just the plugline or balancing factor that attempts to make sense of why neither ultra-low interest rates after the dot-com recession nor QE in the aftermath of the Great “Recession” failed to work as they “should” have. For policymakers, policy rates went low and lower but since no great recovery resulted, especially from the QE’s, it is merely asserted that R* must have been that much lower still…If “real” policy rates had been pushed down to -10%, the still lack of recovery would have left Fed officials claiming R* surely was -10.01%. Link
They are so data dependent that they are always behind. They need to factor in a small amount of anecdoctal thinking. Some snap-shot qualitative surveys. In short, pull your eyes up from the books.
I mean we could all see the utter madness at open homes and auctions last year but the Reserve Bank refused to look.
And now, evidence of a spending slow down seem clear but again RB not interested and thinks neutral may need to be higher.
My money would be that in 6 months time they'll say we are seeing evidence of a struggling consumer and OCR has peaked.
Yes, Uncle Bulgaria, they will drive us into an economic depression. It is depressing to even look. This article states Karen Silk is "steeped in climate change":
https://www.rnz.co.nz/news/business/460343/karen-silk-appointed-as-rese…
I suppose that is almost everything we need.
The neutral rate is pure reckonomics. Keynes tore it to pieces in his General Theory in 1936, and it stayed ridiculed and buried until the 70s when it managed to come back from the dead. Like so many economic theories it has somehow survived despite having zero empirical evidence that it is real or useful.
Even Fed economists have tried to pull people away from giving the neutral rate any credence...
"the link between trend growth and the equilibrium real rate is shown to be quite weak. Overall, we conclude that statistical estimates of the equilibrium real rate will be difficult to use reliably in practical policy applications."
The concept of a neutral OCR is itself flawed.
As long as the OCR is less than the inflation rate, then rather than thinking in terms of stimulatory or restrictive, the RBNZ needs to be thinking in terms of 'distortionary' versus non-distortionary. In that environment, investment in assets which inflate is encouraged and investment in productive assets is discouraged.
KeithW
Price of many raw materials has been dropping for a while now. I think Iron ore & aluminium are 20% down from peak. Give it 6 months to filter through. Oil is well down as well, so inflations probably at it's peak now. We're getting hints of material prices not rising in the building industry.
I wouldn't bet on oil staying low, in fact I think there is a good chance of oil popping much higher and derailing everything:
Is that the same Karen who announced this https://www.stuff.co.nz/business/118848583/westpac-shifts-250-jobs-from…
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