Glass half full

Last week’s Monetary Policy Statement was very much in line with expectations. The Reserve Bank left the OCR unchanged at 1.75% and issued the same forward guidance it has used all year. Essentially, the OCR is on hold, and the RBNZ expects that it will remain on hold until 2019, although there are large uncertainties on both sides.

While the overall tone of the MPS was both neutral and much the same as previous missives, there was a lot going on beneath the surface. The RBNZ acknowledged that the housing market and construction activity were weaker than previously anticipated, and downgraded its forecasts in both areas. This downgrade was overdue – we had complained that the RBNZ was too optimistic on construction and house prices in its August MPS. But offsetting these downside developments, the RBNZ acknowledged that the lower exchange rate will support inflation, and that the Government’s fiscal plans would stimulate the economy.

The standout for us was the RBNZ’s extraordinary optimism about future GDP growth. The RBNZ estimated that the economy grew 0.7% in the September quarter this year, whereas our estimate is 0.4%. The RBNZ went on to forecast that GDP growth will be 0.9% in December 2017, rising to 1.2% in March 2018. That would make March the strongest quarter of GDP growth in four years. These are heroic forecasts, to say the least. In recent times we have seen business confidence dropping away, the housing market slow and construction activity stagnate. With the uncertainty associated with a change of Government lying ahead of us and population growth slowing sharply, we find it highly unlikely that the economy will reach these heights. Our own forecast for GDP growth in the March 2018 quarter is 0.5%.

The RBNZ was also very optimistic on GDP growth over a longer timeframe, based on the idea that the new Government’s policies will tend to boost the economy. In turn, this will apply upward pressure to inflation, necessitating a higher OCR than otherwise. The RBNZ looked at four areas of proposed Government policy: extra spending on education and health, the Kiwibuild residential building programme, hikes to the minimum wage, and plans to reduce incoming migration to New Zealand. On balance it judged these to be a positive stimulus to inflation, necessitating an OCR perhaps 50 basis points higher than otherwise.

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