A change of mood

The persistence of low inflation, despite an obvious acceleration in the pace of economic activity in New Zealand, has been a puzzle for forecasters and policymakers over the past couple of years.

Last week’s Monetary Policy Statement revealed that the Reserve Bank has made some significant new judgements about the extent of inflation pressures in the economy, concluding that interest rates won’t need to rise as quickly in order to keep future inflation in check.

We had already been contemplating the case for a slower pace of interest rate hikes, and in our latest Economic Overview we spent some time reviewing the factors behind low inflation in recent times and whether they would persist. But the sharp change in tone from the RBNZ made a change of call inevitable. These kinds of judgements are always difficult to anticipate, but now that the RBNZ has adopted them, they are likely to stay in place for some time. Consequently, we now think the RBNZ won’t be prompted into raising the OCR again until June next year.

Significantly, it wasn’t as change in the economic environment that motivated the RBNZ’s shift – indeed, our expectation that the RBNZ would take a fairly balanced view of economic developments over the last three months turned out to be correct. Export prices and house price inflation have fallen, but only slightly more than the RBNZ had assumed in the June Monetary Policy Statement. Domestic activity has carried on much as expected, with the upturn becoming increasingly broad-based. And net immigration, which the RBNZ made quite a song and dance about in June, has been much stronger than previously forecast. If anything, the RBNZ has become more confident about the state of the domestic economy, judging by the upgrade to its GDP growth forecasts over the next year or so.