By Roger J Kerr
One can see it happening already, the RBNZ keep interest rates “too low for too long” over the next six months and leave themselves behind the 8-ball in controlling inflation in 2011 and 2012.
Increased interest rate and exchange rate volatility is the result as they realise their monetary policy error by March/April next year and start to play catch-up.
The exact opposite happened in 2006/2007, the RBNZ - swayed by bank economists - tightened monetary policy “too much for too long” and caused the economic recession in 2008/2009.
The RBNZ were seemingly mesmerised and pre-occupied by the residential property market boom in 2006/2007 being the big threat to inflation as retail spending boomed from the wealth effect. The inflation recorded over that and subsequent periods never came from excessive retail demand. The price increases experienced were all supply-side driven or from the uncompetitive public sector. Monetary policy was ineffective in controlling the sources of inflation.
Today, the RBNZ are again citing the housing/retail sectors as the big drives of the economy and thus the only source of inflation risk. Because they are now forecasting house prices to decline by 5% over the next 12 months they do not expect consumer spending to improve at all and thus have concluded that future inflation risks have reduced.
In my view, they are again running the risk of not having monetary policy appropriately set by mis-reading the future economic conditions and will be forced to change their view abruptly by March 2011.
When the RBNZ realise that their +2.6% GDP growth forecast for 2011 is too low, and thus underestimating inflation risks, they will need to get interest rates back to “neutral” (i.e. 5.00%) in one hell of a hurry.
The flip-flop from the RBNZ to suddenly change their 2011 GDP growth forecast from the previous +3.5% to +2.6% is quite disturbing. It appears that because the RBNZ have horribly over-estimated GDP growth in 2010 (they had a forecast of +3.5%, whereas we are on-track for +2.0% annual increase due to very flat domestic spending), they are now running the risk of under-estimating GDP growth in 2011.
They also appear to be looking backwards at historical economic trends and changing their future forecasts accordingly.
One cannot have a great deal of confidence of the RBNZ accurately forecasting the economy in 2011 when they were so far away from reality (+0.2%) with their forecast of +0.9% for the June 2010 quarter, which finished three months ago.
There is something disturbingly amiss with the RBNZ economic forecasting model when they were 0.7% wrong for a historical period where the majority of the components were already known.
There has to be some serious questions asked by someone at the RBNZ about the accuracy of their economic forecasting.
They have the most resources and I do not think it is good enough for them to say that everyone else got the GDP number horribly wrong as well.
At APRM our GDP forecast for the June quarter was always +0.5% as we had recognised that the domestic economy was flat and manufacturing had contracted (partially drought related). Looking ahead, the September and December quarters’ will both be not far away from +0.5%.
However, in 2011 the full positive impact of high export commodity prices will be lifting investment and production across the economy. Export prices and performance have always driven GDP growth in the NZ economy and that situation has not suddenly changed. The RBNZ seem to have forgotten this economic fundamental and focus too much for my liking on domestic housing and retail spending sectors as the dominant determinants.
Investors and borrowers need to factor-in the more probable interest rate scenario over the next 18 months i.e. short-term rates being stable for a few months, however then sharply upwards.
Market interest rates from three years on are determined by US 10-year Treasury Bond yields and I see these as only going one way over the next 12-18 months i.e. upwards due to no double-dip recession in the US and no further quantitative monetary easing from the Federal Reserve.
--------------------
* Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
No chart with that title exists.
3 Comments
The only thing I agree with in this article is that the RBNZ's forecasts are crap.
I actually find myself agreeing with the RBNZ's downward revision to GDP growth in 2011. I think 2.5% or even less is likely. I don't agree with Kerr that something much higher is likely.
For the following reasons:
- unemployment will not drop drastically over the coming year
- the confidence given by rising house prices wil not come
- net migration will be low-moderate
- retail will continue to be flat in 2011
- housing and construction will remain sluggish
I agree that some boost will come from exports, as well as the world cup, but not IMHO enough to drive growth much above 2%
I concur.....I think we will be amazing lucky to see +2% and even +1% in 2011.....is more likely tobe negative IMHO....just how neg swings on who gets in in the US come November....if the Demcrates hold on it may not be too bad but with many of the States in a bad way....they just have to be bailed in the new year so +2% to -4%....If GOP gets in they freeze up the Govn and the States wont be bailed and the Fed will be hog tied....-2% to -10%....way ugly....
We welcome your comments below. If you are not already registered, please register to comment.
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.