The Reserve Bank (RBNZ) wants to keep some pressure on domestic inflation, even as it moves quickly to bring the Official Cash Rate (OCR) closer to a neutral level.
Policymakers have cut the benchmark interest rate by 125 basis points over the past three meetings to 4.25% and are signalling another 50 point cut to 3.75% in February.
The neutral interest rate—which neither stimulates nor restrains growth—is estimated to be between 2.5% to 3.5%, meaning the OCR will remain restrictive until at least April next year
Paul Conway, RBNZ’s chief economist, said this was necessary as domestic inflation was still simmering at 4.9% in the most recent data released and needed to be tamped down.
“We're confident that it's going to keep coming down, because we've got excess capacity in the economy, but … the reason we've got that is because of the OCR track that we published yesterday,” he said in an interview.
“If we were to just go huge and cut the OCR to neutral yesterday, it becomes more likely than not that domestically generated inflation flares back up”.
RBNZ forecasts non-tradable inflation will be 4.7% in the December quarter and drop to 3.2% by the end of next year. It averaged 2.7% in the 10 years prior to the pandemic.
While rates will remain somewhat restrictive for a few more months, Conway said they were falling enough to restart economic growth after two years of stagnation.
“Having interest rates 250 basis points above neutral is quite different to having them 50 or 100 points above neutral,” he said, and lowering interest rates in real terms will affect GDP growth.
“Straight away, you can almost feel it in the streets. When I go out after we've done a 50 [point cut] you can just feel a little buzz. Because, it's affecting people's perceptions and projections of where the economy is going”.
Future growth would be at a “typical New Zealand, mediocre, muddling along, she’ll be right” annual rate of about 2.4%, Conway said, and going faster would require economic reform from the government and a change in Kiwi business culture.
He said now was a good time to be talking about structural reform with the Covid crisis and its economic hangover moving into the rear vision mirror.
“Inflation's in the band. Interest rates are going down, and growth is recovering. So from a cyclical perspective we're in good shape.”
“But I fully acknowledge it's been hard work [for New Zealanders] to get us into this position where inflation is sustainably back at target.”
Conway said the nearly three-month gap until the next policy decision would be useful, as it allows time for a full set of new data releases and to see the effects of earlier decisions.
Shadow boxing
Earlier, at a hearing with Parliament’s Finance and Expenditure Committee, RBNZ policymakers said it wasn’t known how President Trump’s policies would impact inflation.
Deputy Governor Karen Silk said the new administration’s trade policies as well as geopolitical tensions had been discussed by the Monetary Policy Committee.
“It probably has a net inflationary impact at global level and potentially a net negative impact on growth,” she said, however that may not be the case in New Zealand.
“Those that are selling into economies that are imposing tariffs may well seek substitute markets, and so we could see dumping of goods.”
An example of this occurred in 2021, when COVID lockdowns led to a drop in demand for potato chips in Europe, causing one supplier to dump excess frozen fries into the NZ market.
Silk said tariffs in the United States could mean cheaper electric vehicles becoming available here, as an example.
Conway said none of these possible outcomes had been modelled and it was not really possible to predict how these dynamics would play out.
“President-elect Trump, he talks a lot, but what will actually be put in place?" he asked.
"It would be remiss of us to be reacting. We'd be boxing at shadows currently, if we were to incorporate it, I don't even know what it would mean — lower interest rates or higher interest rates?”
Markets and politicians have had a taste of things to come this week, after Trump threatened 25% tariffs against Mexico and Canada on his own social media platform.
Mexican President Claudia Sheinbaum responded on Wednesday with a promise to retaliate with measures that could cost the United States hundreds of thousands of jobs.
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