Reserve Bank Assistant Governor Karen Silk says the Official Cash Rate is working despite sticky core inflation and record high employment

Karen Silk, Reserve Bank Assistant Governor, says there is good evidence the Official Cash Rate (OCR) has begun to cool domestic inflation despite slow progress. 

Headline inflation has been falling for the past year, but non-tradable inflation only peaked at 6.8% in March and has fallen just 0.2 percentage points since. 

One of the Reserve Bank’s primary measures of core inflation has been stuck at 5.8% for the past three quarters, although others have declined. 

Silk said headline inflation was always going to fall faster than core inflation. Plus, the full effect of higher interest rates hadn’t been felt in the real economy yet. 

The average mortgage rate has been steadily climbing towards 6%, as more and more households roll onto rates above 7%, and will hit that level in early 2024.

And while core inflation has only just begun to fall, there are plenty of signs the OCR was working to restore balance in the economy.  

“Are we seeing an easing in domestic consumption, yes. Are we seeing falling forward orders for business, yes. Is durable spending coming down, yes,” Silk said. 

Another piece of evidence was how few loans were being made across almost all sectors. 

Demand for residential mortgages fell 32.9% in the six months ended March, and was expected to fall another 25% in the six months after. 

Inflation forecast 

The Reserve Bank expects non-tradable inflation to be lower in the coming quarter, but only on an annual basis. The actual quarterly rate may be the second hottest in recent years.

It has been forecast to be 1.7% in September this year. That would be equal to the March 2023 quarter and only a little behind the fiery 2% seen in September 2022.

Both headline and tradable inflation will be high as well, though. This hot-spot is mostly due to higher petrol prices and annual increases to local rates and insurance premiums.

Higher petrol prices could lead to tradable inflation having its hottest quarter in two decades and even lift the annual rate. It was 5.2% last quarter, but may be 5.8% in September. 

But that’s not the type of inflation the Reserve Bank spends its energy fighting. The OCR mostly targets domestic, or non-tradable, inflation. 

While the quarterly figure will be fairly hot, the annual number has been forecast to fall to 6.2% from 6.6% last quarter. 

This decline is because prices also spiked last September and that increase will drop out of the 12-month period. It is not because inflation will ease during the quarter. 

All this means the central bank may be in for a bad news cycle this September.

Headline inflation—which combines tradable and non-tradable inflation—may stall at 6% for a second quarter in a row.

But after Super September, things are supposed to get back on track quickly. The Reserve Bank forecasts annual headline inflation to be back in the target range exactly one year later.

In defence of forecasting

Karen Silk said the Reserve Bank’s forecasts were about as accurate as any other local economic institution. 

The central bank was criticised by National’s Nicola Willis last week for missing its inflation forecast by two percentage points. 

One year ago, the Reserve Bank had picked inflation to be at 4.1% in the June quarter, but it printed at 6% instead. This forecast had been updated in May and correctly predicted the actual rate. 

“We make forecasts based on the information that is available at that point in time, and as we know, data changes all the time,” Silk told Interest.co.nz. 

Long-range forecasts were really a “central projection” and were revised every six weeks ahead of Monetary Policy Committee meetings. 

But this does cast some doubt on whether inflation will drop below 3% in September 2024, as predicted.

Kelly Eckhold, chief economist at Westpac NZ, noted the central bank appeared to have chosen that date as its target for getting inflation back into the 1% to 3% range.

It has been forecasting that date since November 2022, despite various changes in economic conditions and sticky domestic inflation. 

Eckhold expects another rate hike will be required to achieve that goal, likely at the end of this year. However, the Monetary Policy Committee itself has signalled it is very comfortable with the OCR at 5.50%. 

Even as their financial models have hinted at another rate hike, the seven committee members have judged it may not be necessary.  

Stephen Toplis, head of research at BNZ, shares this view. He said there was a risk the economic downturn could be more than anyone had anticipated.

“The BNZ-Business New Zealand PMI and PSI have both turned nastily negative, dairy commodity prices are slumping … spending on discretionary items is falling, surging petrol prices and rising interest rates are squeezing the household sector, and the recent boom in immigration and tourism looks set to slow.” 

“What chance is there against this backdrop that the Reserve Bank would raise its cash rate any time soon? Very little is what we would contend," said Toplis.

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