November 26, 2021
The RBNZ’s Monetary Policy Committee (MPC) raised the policy rate by 25bps to 75bps earlier this week, the second such move in the last two months and gave a clear signal that more such increases are in the pipeline.
The move came as inflation pressures were judged to be escalating and after the New Zealand economy reached a record low unemployment rate of 3.4%, more than enough to be consistent with ‘full employment’. Indeed, the RBNZ described employment as being “above its maximum sustainable level.”
Meanwhile, inflation at 4.9%, is well above the RBNZ’s 1-3% target and forecast to accelerate further to 5.7% by the March quarter next year. New forecasts published by the RBNZ also show the cash rate rising to 2% by the end of 2022, a year sooner than projected just three months ago.
Understandable difference of messaging between RBNZ and RBA
The RBNZ is a long way from a template for the RBA. In the first instance, there is a large gap in the messages being sent by both central banks with the RBNZ out in front of most other central banks in terms of withdrawing monetary stimulus and the RBA indicating a determination to be a global laggard when it comes to the withdrawal of monetary stimulus.
RBA Governor Phillip Lowe has indicated that he doesn’t expect the conditions for an increase in the policy rate before the end of 2023 and has said he regards any policy increase in 2022 as “extremely unlikely”. That is understandable given the current more intense inflation pressures in New Zealand and the larger relative amount of labour market ‘slack’ in Australia.
Could the New Zealand experience be a cautionary one? Asymmetric risk distribution around the RBA “central scenario”
However, the RBNZ experience might be a cautionary one for the RBA. New Zealand is an example not only of how quickly the economic environment can change but more importantly of the inherent uncertainties attaching to the economic outlook and attendant monetary settings which are particularly manifest at the current time.
RBA communication might be better nuanced to place some emphasis on the inherent uncertainties attached to the economic outlook and attendant monetary settings. It is a fact that central banks (like markets) are imperfect forecasters of their own actions. That is more apposite than usual in the current highly uncertain environment as economies emerge from the dislocations wrought by the pandemic.
By failing to acknowledge that the RBA quite frequently “doesn’t know what it doesn’t know” and making assertions about the wage and price outlook in 2022 and the “extremely unlikely” event of a policy rate hike in that year (and well into the following year) the Governor risks denying himself the requisite wiggle-room. The continued confusing conflation of ‘outcomes-based forward guidance’ (OBFG) with calendar guidance is not helpful and certainly not necessary.
In my view, Australia will not be immune to an ongoing inflationary impact from ongoing supply disruptions and other factors that account for greater persistence in inflation in the developed country complex. And, as stated above, even if one were to accept that the current inflation outcomes globally are an exclusive product of supply disruptions, nor is it axiomatic that such inflation effects are “transitory”.
In his Australian Business Economists (ABE) appearance Governor Lowe firmly embraced the “transitory” inflation rhetoric that a number of other central bank chiefs trotted out in the first half of this year. Now those same central bank chiefs are disengaging from that “transitory” rhetoric because it is either not accurate or not helpful or both. Of course, as the Governor suggests, the Australian economy is “different” from other developed economies: it may well be; but not sufficiently so that the same laws of supply and demand and their effect on prices do not apply.
An implausible ‘central scenario’?
None of this is to suggest that the RBA “central scenario” is implausible. It certainly is not. One risk not addressed by the Governor but one which I’m sure is front-of-mind is the potential fallout from a downdraft in Chinese growth to which Australia is more highly exposed.
Nor does it suggest that the RBA have not proved themselves in their management of monetary policy during the pandemic, where it has exhibited a noteworthy proficiency.
But that “central scenario” is one firmly rooted in the downside end of the inflation risk continuum.
It appears that the RBA is still backward-looking, perhaps burdened by an ill-timed – even clumsy – embrace of OBFG. Monetary settings remain close to those consistent with an “emergency” and the RBA creates the impression that it is dismissive of the upside risks that have been starkly revealed elsewhere in the developed country complex.
By not acknowledging it “doesn’t know what it doesn’t know” and that inflation risks are asymmetrically weighted to the upside, and that, accordingly, policy rate increases may be required earlier, the RBA potentially depreciates the utility of future communication with an attendant weakening in the high regard with which it is currently held in financial markets.
Stephen Miller is an Investment Strategist with GSFM. The views expressed are his own and do not consider the circumstances of any investor.