Stamp of approval

Last week the Reserve Bank gave the official stamp of approval to the sentiments that Assistant Governor John McDermott delivered in a speech the previous week. As the speech explained, the RBNZ has stepped away from its previous neutral stance on the OCR outlook. Instead, the RBNZ has adopted a conditional easing bias.

The key policy guidance paragraph in last week’s OCR Review was:

“The timing of future adjustments in the OCR will depend on how inflationary pressures evolve in both the non-traded and traded sectors. It would be appropriate to lower the OCR if demand weakens, and wage and price-setting outcomes settle at levels lower than is consistent with the inflation target.”

This means that the OCR is on hold, unless two conditions are met, in which case the OCR could be reduced. The OCR will be cut only if demand weakens and wage and price-setting behaviour settle below the inflation target. The word “and” is very important here – both conditions have to be met.

The second of these conditions, that wage and price-setting behaviour settles below the inflation target, is certainly at risk of being met, although not until later this year. Surveys of inflation expectations have already dropped to about 2%, and in our view they could yet drop further. The RBNZ has pointed out that its market-based and model-based measures of inflation expectations are below the target, and its “factor model” of core inflation is currently 1.3%. Just last week the ANZ Business Outlook survey showed that businesses retain low expectations of inflation, and fewer firms intend to raise their prices. Next week we expect labour market data to show that wage growth is stuck at a very low level.