Giving inflation a chance

Both the RBNZ and US Federal Reserve met in mid-March and delivered decisions that underlined their determination to lift inflation from its recent low levels.  By keeping policy interest rates lower for longer, both central banks have given themselves a greater chance of hitting their future inflation targets.

The RBNZ’s decision to cut the OCR came as a surprise to many local economists who had ruled out a move in March based on the Governor’s speech on 3 February. To recap, in February the Governor said that it would be wrong for the RBNZ to take a “mechanistic approach” to current low headline inflation, as that would not draw on the flexibility in the Policy Targets Agreement (PTA). 

While some bank economists may quibble with the timing, they were all expecting an OCR cut at some point in the first half of 2016.  The evidence in favour of a cut became overwhelming given an elevated NZ dollar, a further fall in dairy prices, a moderating Auckland housing market, higher wholesale overseas funding costs for banks, and fragile global financial markets. 

However, the key factor that tipped the RBNZ to act decisively was the sharp fall in inflation expectations.  Up until December, the RBNZ were clinging to the idea that NZ inflation expectations remained “well anchored”, despite survey measures trending down from 2.5% to 2.0%.  The survey measures fell materially again in February.  It is hard to remember a domestic development causing the RBNZ “concern” since the Christchurch earthquakes.  However, that is the language the RBNZ used to describe the prospect of low inflation becoming imbedded stubbornly into wage and price setting behaviour.