Analysis: Reserve Bank Governor Adrian Orr has said last week’s Budget was “contractionary” not inflationary, that the Reserve Bank’s Monetary Policy Committee is “extremely confident that we’re on top of this inflation issue”, and that monetary conditions are slowing spending in the economy and “taking the inflation pressure out".
Speaking on Breakfast this morning Orr said all of “that is good news”, and it means yesterday’s 0.25% increase in the Official Cash Rate (OCR) comes with “a message to people” that we can sit “where we are for some time".
Those of you who follow these things will already know that.
But if the OCR is intimidatingly mysterious, and the Reserve Bank has sometimes had a predilection for calling a spade an inverted digging implement, Orr was essentially telling us to keep calm and carry on.
“We’re seeing inflation pressure easing, we’re seeing spending slowing”, he told Breakfast, “so that is giving us confidence that if we show patience we are on the right path".
What does that mean?
The right path for whom?
Read the Monetary Policy Statement
Firstly, it probably means the OCR has gone about as high as it’s going to go, for a while.
Certainly, that’s the message markets have taken from the Reserve Bank.
And Orr himself has said that in interviews, including on Breakfast, with the proviso that the Reserve Bank has to react to the economy as it is, not as they predict it will be, so he can’t absolutely guarantee anything.
To understand this, we need to dig a little.
Orr asked Breakfast viewers to go online and “read the Monetary Policy Statement for themselves”.
Indeed, Orr kept asking people to do that. “It’s written for interested non-experts”, he said. “It’s an incredibly informative document.”
At this point, Orr reminded me of my teenaged self, showing bored friends my new Echo and the Bunnymen album - and getting no traction whatsoever.
“Go to the water yourself,” Orr implored Breakfast viewers, “and drink from there”.
So, I did.
The Monetary Policy Statement (MPS) looks like it was prepared by the Department of Conservation. Its cover features a wooden walkway through native tussock, heading down to a lake or a fjord. (This must be the “water” Orr was asking us to go to and drink from.)
There is not a person to be seen. No spending is taking place. Unless weka have credit cards, it's the least inflationary environment in the country.
The MPS begins with the most meaningless sentence in the history of the English language: “The Monetary Policy Committee’s (MPC’s) monetary policy strategy is its overarching plan for how it will formulate monetary policy under different circumstances to achieve its objectives.”
I didn’t make that up for laughs. That really is the first sentence. For a document reputedly intent on being “incredibly informative”, that’s not a great start. It may have been written by someone who was gently stoned. (“Heeeeey dudes, what about this?”) I keep reading it, over and over, and here’s what I think it means: We will do stuff.
Low inflation is sometimes achieved by increased unemployment
This is where things get more interesting (although, that’s quite a low bar).
Under the Reserve Bank of New Zealand Act 2021, the MPC (Monetary Policy Committee) is responsible for keeping “future annual inflation between 1 and 3 percent over the medium term, with a focus on keeping future inflation near the 2 percent mid-point”, and it’s also responsible for supporting “maximum sustainable employment".
That’s kinda clear. Although, and I’ll write about this another time, low inflation is sometimes achieved by increased unemployment. In other words, keeping inflation and unemployment low at the same time isn’t always achievable.
But let’s return to the OCR, which is now sitting at 5.5%.
In the past 24 hours, some of the coverage of yesterday’s 0.25% increase has felt ever-so-slightly overdone. As if the Reserve Bank has pushed a big, red button.
But that button was pushed last year.
Look back on what Bernard Hickey wrote last November on his excellent website, The Kākā: “Adrian Orr has just demonstrated his inflation-fighting resolve and political independence with a volley of monetary policy tightening and tough talk that will shock parts of the economy to a standstill."
Hickey was responding to the Reserve Bank’s decision to tighten the OCR by 75 basis points (three times more than yesterday’s increase) to 4.25%. As Hickey pointed out, and he wasn’t remotely alone in doing so, this was “the biggest rate hike since the OCR began being used in 1999".
That the OCR had moved from 0.25% to 4.25% in just over a year was “buckle up New Zealand” material, to quote my motor-racing obsessed former colleague Clint Brown.
And, at the time, Orr and the Reserve Bank forecast exactly what happened yesterday - that the OCR could get as high as 5.5%.
This was widely reported. In other words, yesterday’s increase had explicitly and repeatedly been signalled.
“The RBNZ now sees the OCR rising to a peak of 5.5 per cent in 2023”, wrote the New Zealand Herald, last November. “Today's increase to 4.25% is not the end, with a peak of 5.5% predicted by the middle of next year”, wrote Stuff. 1News, RNZ, Reuters, Newshub - everyone said this was coming.
And that’s because the Reserve Bank told us.
So, yesterday’s announcement is actually less interesting than where the Monetary Policy Committee says we’re heading next.
And that’s why we drink, as so passionately encouraged by Orr, from the water of the Monetary Policy Statement (MPS).
Will the OCR go higher?
So, let’s use it to try to answer some simple questions.
Will the OCR go higher? Probably not. Funnily enough, the MPS isn’t as declaratory about this as the Reserve Bank’s own commentary has been.
And not, for example, as confident as Orr himself was on Breakfast. Orr’s issue, of course, is that the world is an uncertain place. Further to that, post Gabrielle, a massive rebuild is taking place, and rebuilds stimulate economies, and stimulated economies are inflationary.
Orr said this on Breakfast: “Where the challenge has come for the Government is obviously the investment that is needed to rebuild larges swathes of the North Island."
But the tea leaves are good. “Consumer spending growth has eased and residential construction activity has declined, while house prices have returned to more sustainable levels”, the MPS tells us. In other words, radical increases in interest rates don’t look like they’re required.
And here’s where the MPS is really helpful. If you’re reading it, or drinking from it, go to Chapter 7 – Appendices (You know you want to - you know Orr will be so grateful). Here, the Reserve Bank lays out its own forecasts. And, clear as alpine water, the OCR peaks at 5.5%. That’s the level it reached yesterday. That’s the level the Reserve Bank is forecasting, all things being equal, it will go no higher than.
How long might the OCR remain at this level? “The OCR will need to remain at a restrictive level for the foreseeable future.” How long is foreseeable? Well, the MPS looks outwards at projections and says: “Market participants expect the OCR to begin declining from its peak level later this year.”
But, and this is a big but, if we go back to the highly useful forecasts in Chapter 7 – Appendices, we see that the OCR is forecast to remain at 5.5% until the middle of next year. That’s interesting. (Dad joke.) By 2025, the Reserve Bank is forecasting the OCR will sink below 5.0% again, falling below 4.0% in 2026, but next year, it’s predicted to stay above five.
Where is unemployment heading? This is important. First, the MPS says: “the unemployment rate is expected to increase from its current low level.”
That is no surprise to anyone. And then the MPS says: “Keeping the unemployment rate near current levels without experiencing unsustainably high wage and inflation pressures would require structural changes in the labour market that are beyond the control of the Reserve Bank.”
This goes back to the conundrum that very high levels of employment tend to be inflationary. And, the Reserve Bank repeatedly tells us, as inflation falls, unemployment will rise: “Given the expected slowing in domestic demand, a higher unemployment rate is likely.”
Again, Chapter 7 – Appendices offers us a crystal ball, of sorts. Unemployment is forecast to rise to 5.4% late next year. That’s a significant increase. Meaning significant pain for some. And it’s in the same area as Treasury’s projections for the same period.
It should be pointed out, this figure is coming off a freakishly low base, and it’s close to our historical average. But unemployment is forecast to rise. Significantly.
Where are rates heading?
Where are mortgage rates heading? Here, the MPS answers in a kind of a riddle. “The 1-year mortgage rate”, it tells us “is currently around 60 basis points higher than the 5-year mortgage rate, which is the largest absolute difference since 2008.” What that means, is that banks are expecting rates to fall, but not quite yet.
This tallies with the RB’s OCR forecasts. Interest rates will fall, in a while. The second half of 2024 looks likely.
All of this is variable. These are such uncertain times.
But the next year will be tough for some, and tougher for others.
Those who escape it will be the better off. (Life so often works like that.)
Over the next few weeks, we’ll look at how each party is intending to address the issue of supporting those who need support, without stimulating inflation.
That’s when the figures leave the pages and become people.
Orr wants you to read the MPS. The thing is, you’re already living it.