Reserve Bank running Hot N Cold
Mon 10 Jul 2023 by Gareth Kiernan in Monetary policy

This opinion piece was first published on Stuff on 10 July 2023.

“You change your mind like a girl changes clothes” – Katy Perry’s hit song might as well have been about Adrian Orr and the Monetary Policy Committee. Throughout this year, the Reserve Bank’s official cash rate (OCR) decisions have created uncertainty in financial markets as the tone of the statements has continually jumped between tough-talking and relaxed. This week, based on the Bank’s last forecasts published in May and most economic data to hand, everybody’s expecting the OCR to stay on hold. But are we about to be surprised again?

In April, markets were not expecting the Bank’s hawkish tone and a 50-point increase, given February’s comment that inflationary risks “had moderated somewhat since the November Statement” and the accompanying record-equalling 75-point increase. Then in May, the Bank’s signal that the OCR could be at its peak seemed inconsistent with both its previous thinking and the more expansionary fiscal stance taken in the government’s 2023 Budget. Short-term wholesale interest rates moved by 20-30 basis points on both occasions, up in April and down in May.

To be fair to the Reserve Bank, we are close to, or at, the turning point in the interest rate cycle. This point in the cycle probably has the widest variation in economists’ judgment of the most appropriate interest rate settings. Furthermore, the shocks that have been thrown at the economy over the last three years have made forecasting much more challenging than normal.

The Reserve Bank must also retain the right to surprise financial markets when it believes the markets have got their interpretation of the economy fundamentally wrong. But switching between a dovish and hawkish tone and back again in such a short period of time is not helpful for anyone. The Bank’s current vacillation has echoes of some prior governors, when decisions made at OCR reviews didn’t always reflect the tone and signals from the previous statement. The difference now is that the interest rate decisions are being made by committee, so the decisions should be less affected by how an individual person is feeling on the day in question. So much for the change in structure leading to any discernible improvement in the process and outcomes, at least from the outside.

Perhaps the biggest irony of this year’s OCR reviews is that they fly in the face of the Reserve Bank’s 2021 portrayal of itself as a kōtuku in making monetary policy decisions, taking “small considered steps”. This kōtuku metaphor was arguably a factor behind the Bank’s decisions to lift the OCR only gradually, by 25 basis points at a time, during late 2021 and early 2022, even as inflation accelerated and became more embedded throughout the economy. In fact, at the time of the November 2021 decision, Infometrics said that such a “considered” move was “birdbrained and spineless” given the clear inflationary pressures. Recently, however, the Bank appears to have abandoned the “considered” persona. Instead, it has been more akin to a fantail, flitting from branch to branch, meaning that you’re never sure where it’s going to land next.

“I should know that you’re not gonna change”

Back to this week’s review. Data over the last six weeks has been encouraging from the perspective of getting inflation under control. GDP data showed the economy slipping into a mild recession in the March quarter and was worse than the Reserve Bank expected. Indicators of cost and pricing pressures and expectations are easing, backing up the view that inflation has peaked. Shorter-term mortgage rates have also been edging higher, reinforcing the tightening work the Bank has been doing in previous months. In short, there’s certainly no new pressures that have emerged to say that the Bank was wrong in May and that the OCR needs to do more work. The fact that two members of the Committee voted against the increase in May adds further weight to the idea that any decision to hike now would be unlikely.

If the interest rate rises so far are not enough, which seems to be a big “if”, we think it will be November before the Bank has enough evidence that it needs to do more. By then, according to the Bank’s forecasts, we will have data showing another contraction in GDP in the June quarter, inflation at 5.7%pa and clearly trending down, and the unemployment rate over 4%. We are broadly in agreement with the Bank’s assessment of where these key indicators will head, ruling out the need for any further rate hikes by November. The Bank would probably be comfortable with one of these indicators remaining stronger than anticipated, but the failure of two or all three to weaken would probably force a further tightening in monetary policy.

Apart from the need to wait and see how the economic data unfolds, it’s also likely the Reserve Bank will want to avoid changing monetary policy in the lead-up to October’s election. At times in the past, the Bank has changed interest rates ahead of polling day, but generally these moves have been necessary and obvious, such as during the onset of the Global Financial Crisis in 2008. Things are far from obvious this time around, so any interest rate increase would risk looking political.

All in all, it’s hard to come up with a justification for changing course again, and so we expect no change to the OCR this week. But given recent experience, we’re slightly nervous that such a change is exactly what the Reserve Bank might do. It’s over to the Committee to communicate both its decision, and tone, accurately.

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