Backward Kiwis More Touchy on Their Currency
Another confusing RBNZ policy statement where they managed to upgrade their growth outlook, despite recent weaker activity indicators, and yet downgrade their inflation forecasts, and end up with no change in their rates outlook. They see the higher exchange rate since May has dampening their inflation outlook. And have come to see their fellow Kiwis as more backward-looking in their price setting behavior, further dampening the inflation outlook. The RBNZ tried to emulate the RBA by sounding tougher on their exchange rate views, but it all gets a bit muddled, and Wheeler and gang don’t quite have the cache and charisma of RBA’s Governor Lowe and team, so it doesn’t come off.
Rates outlook unchanged
The NZD has firmed since the RBNZ statement. It is not exactly clear why; perhaps the market was looking for some downward revision to its rates forecasts?
Some media commentators had said that the NZD fell recently on speculation of lower rate forecasts. However, the RBNZ has and still has rates forecast to remain on hold for the next two years before a very gradual rise towards the end of their three-year forecast horizon.
These rate projections are low considering that rates at 1.75% are well below the RBNZ estimate of neutral of 3.5%, and the economy is expected to grow above potential from a zero output gap starting point.
There is not a case for them to project rate cuts, and little reason for the market to have thought this to be the case.
The main take away for the market is that the rates outlook is unchanged since the May policy statement.
Lower exchange rate needed
The RBNZ has, however, made a bigger effort to talk down the exchange rate. The NZD popped up after the June 22 policy statement because the market thought the RBNZ might make a bigger deal of the rise in the exchange rate. At the time it said, “A lower New Zealand dollar would help rebalance the growth outlook towards the tradables sector.”
This time the RBNZ said, “A lower New Zealand dollar is needed to increase tradables inflation and help deliver more balanced growth.”
They inserted the word “needed,” in place of “would help” and linked this need to its inflation outlook.
Within the statement, it said further that, “The exchange rate remains higher than is sustainable for balanced growth in the economy and continues to dampen import prices and tradables inflation.”
The RBNZ said, “The TWI has appreciated around 5 percent since May and is currently around 3 percent higher than forecast in the May Statement.”
“The New Zealand dollar TWI is assumed to depreciate over the projection to around 75, but remains higher throughout the projection than assumed in the May Statement.”
The TWI is 77.3 today; it was 78.1 when the August MPS forecasts were finalized. It was around 75.0 at the time of the May MPS. So it was up by around 4% between the May and August MPS forecast dates. Although the August MPS said it is 5% higher (1% rounding error).
The RBNZ described their reaction function to the exchange rate as follows:
“If a higher exchange rate were to reflect weaker conditions overseas, it could necessitate more-stimulatory monetary policy to offset the impact on inflation. However, a stronger exchange rate due to stronger domestic conditions could be accompanied by increasing capacity pressure, in which case a monetary policy response may not be necessary.”
The RBNZ is slipping in a subtle warning that it may be prepared to cut rates again if the exchange rate rises. At this stage its forecast for growth are robust and it still has inflation getting back to target in a couple of years, so there is no need to cut.
Part of the reason is stronger terms of trade (higher export prices and lower import prices) since the May statement have supported the growth outlook and helped offset the rise in the exchange rate.
So cuts to quell the currency are not on the table yet.
The RBNZ lowered its inflation outlook
Since the May MPS, their headline inflation forecasts have been revised lower by a significant margin up to mid-2018, and then are essentially the same after that. Inflation gets to the 2% target around the beginning of 2019.
The RBNZ said the lower inflation forecasts are “due to persistently low global inflation and the high New Zealand dollar exchange rate.”
“As tradables inflation is projected to be low, a rise in non-tradables inflation is necessary for headline inflation to settle around the target.”
It interesting that the RBNZ is striving for higher non-tradables inflation, well above the 2% target, to offset a subdued forecast for tradables inflation.
“Based on the outlook for commodity prices, global inflation and global policy rates, tradables inflation is expected to remain below its historical average for some time. Accounting for this weakness, a strong lift in non-tradables inflation is necessary for inflation to settle near the target midpoint in the medium term. Non-tradables inflation and core inflation remain subdued at present.”
In other words, the high exchange rate is contributing to a persistently low interest rate outlook designed to drive the domestic economy into a significant positive output gap, and lift non-tradables inflation well above the RBNZ target.
The RBNZ’s inflation forecasts are for a significant rise in non-tradables inflation. Nevertheless, these too have been revised down somewhat over the next year and a half since May.
Backward looking Kiwi’s
The RBNZ said their recent research suggests that price setting behavior in the economy is more backward looking than they had previously thought. As such low inflation in recent years will tend to be more persistent. And the economy has to grow more significantly above trend to generate the desired higher inflation outcomes in the RBNZ’s three-year horizon.
The RBNZ said, “Low past inflation appears to be contributing to weak price-setting behaviour by businesses. This is creating a drag on current and future inflation. These weaker price-setting dynamics suggest a need for stronger capacity pressure than might otherwise be necessary to generate a given level of inflation.”
“The implication is that recent weak pricing dynamics are likely to act as a headwind to inflation over the forecast horizon, suggesting that the stance of monetary policy needs to be more accommodative than otherwise.”
Higher GDP forecasts
The RBNZ have actually boosted their GDP forecasts since May. This is kind of surprising considering some weaker than expected activity data since the beginning of the year. However, the key underlying forces supporting growth remain intact, or have improved. (immigration, terms of trade, fiscal expansion, low interest rates).
“GDP growth is forecast to strengthen, with annual growth averaging 3.4 percent over the next two years. This pace of GDP growth is above estimates of growth in potential output, leading to an increase in the output gap. Low interest rates, along with rapid population growth, continue to underpin the growth outlook. Also contributing is a recovery from temporary weakness in GDP growth through late 2016 and early 2017, and contributions from the high terms of trade and fiscal stimulus.”
The table below shows that the RBNZ has added 0.1% to quarterly growth forecasts from Q3 this year to Q1-2019, and then 0.2% to quarterly growth in Q2 and Q3 2019, and +0.1% in Q4-2019.
As such, the RBNZ remains quite upbeat on growth despite recent weakness in GDP. In fact, they argue that the recent weakness in growth will result in a bounce back in coming quarters.
However, as discussed above, due to the higher exchange rate and backward looking Kiwis, the higher growth outlook is not enough to lift the inflation outlook that in fact has been revised lower.
No need to follow policy moves abroad
The RBNZ have kind of tried to emulate the RBA on their exchange rate and rates rhetoric. In a similar vein to the RBA, the RBNZ said that less policy accommodation abroad will not be followed by the RBNZ.
They said, “Although central banks in some major advanced economies are starting to raise interest rates, or beginning to consider a gradual lessening of monetary stimulus, it remains appropriate for monetary policy in New Zealand to remain accommodative. With domestic inflationary pressure remaining subdued, the Official Cash Rate (OCR) is projected to remain low for a prolonged period.”