June 08 OCR review and MPS

The Reserve Bank left the official cash rate unchanged today at 8.25% – inline with the expectations of most if not all market analysts. However, as always, the devil was in the detail.

Starting with the statement, the language surrounding potential cuts changed completely. In March (*) we had “the OCR will need to remain at current levels for a significant time yet” then in April (*) “the OCR will need to remain at current levels for a time yet”. However in June we got:

Provided the economy evolves in line with our projection, we are now likely to be in a position to lower the OCR later this year (*)

With the RBNZ picking an annual inflation rate of 4.7% by September they are effectively stating that if the June CPI number is weak (or even moderate), rates will be cut by July.

Further detail was in their Monetary policy statement for June (effectively their forecasts).

Several things have changed significantly since their March MPS (*):

  1. TOT forecasts,
  2. CPI forecasts,
  3. Consumption and employment forecasts.

Terms of trade

Here the Reserve Bank had the terms of trade falling to 2005 levels by late-2008. As they expect oil prices to fall this can only be the result of a fall in export prices. This is surprising given that world growth is expected to still be 2.9% (compared to a forecast of 3.1% last time).

Overall, I’m unhappy with this change – it seemed like an artificial way of driving down domestic economic activity in their forecasts.

CPI

Inflation of 4.7% by September – makes my 5% comment sound reasonable 🙂

Overall this pick would be on the high side of market expectations. If June CPI really is lower than 3.8%, this would give the Bank a reason to cut rates.

Non-tradable inflation eases more quickly than I would expect in their forecast, especially from September onwards – this stems from their outlook for the labour market.

Employment

Negative employment growth for 3 years! The unemployment rate lifts to 6.0%! Sure employment intentions have eased over the past few months – but such a sharp and persistent turn in the labour market is unfathomable. Add to this the fact that a number of the shocks hitting our growth are temporary supply shocks and such a significant downturn in the labour market seems incredible.

The shocks to the labour market stem from the view that the demand side of our economy is softening – specifically the household sector.

Consumption

Private consumption growth of 0.4% over the March 09 year, -0.2 in March 10 and 0.1 in March 11. They are expecting one hell of a reduction in consumption – and as a result a huge increase in private savings (with disavings falling from 14% of disposable income to 5%).

Now I agree that we will see an increase in savings in the near term – but my goodness, this is ridiculous. Liquidity is likely to remain abundant, and they are forecasting a significant cut in interest rates by this period – so why is savings rising? (I guess income insurance, and also as a way of trying to recover savings following the fall in house prices, and also maybe lower long term growth expectations could be a justification – even though there potential output level is relatively constant).

Overall

It seems that the Bank is going to cut rates sooner rather than later – however I’m not supportive of this idea if we truly wish to control inflation.

Update: Read the review of this statement by Westpac – they are exactly right!

Update 2: Bernard Hickey goes into detail about why this early cutting is a bad idea. The money quote is

non-tradeables inflation is a major factor and has been elevated above 3% for nearly six years. Non-tradeables inflation has never been below 3% during the governor’s term, yet he is forecasting a fall from 3.9% to 2.5% between December of this year and September of next year. This is worthy of scepticism.

Damn right!

  • They expect inflation to stay above the top of the target band until late 2009, hitting 4.7% in this September quarter. We’ve been above the target band since December 2007 quarter. So two years above the target band is somehow consistent with inflation being within the target band in the medium term.

    The medium term gets longer all the time. 5 quarters, 8 quarters, whatever.

    We don’t really need to worry much though. There’s no literature whatsoever suggesting that central bank credibility is important. Any reports to the contrary are just ideological burps coming out of strange macroeconomists and can be ignored.

  • “The medium term gets longer all the time. 5 quarters, 8 quarters, whatever.”

    Agreed – I can’t see annual price increase settling below 3% over the next five years given this sort of Reserve Bank action. Did someone say policy failure?

    “We don’t really need to worry much though. There’s no literature whatsoever suggesting that central bank credibility is important. Any reports to the contrary are just ideological burps coming out of strange macroeconomists and can be ignored.”

    🙂

    Don’t forget what the RBNZ said just today – “inflation expectations are anchored” 😀

  • I just played a bit in Excel. If you centre around the current quarter and take their inflation expectations, then project 2.6% forever after March 11, guess how many quarters it takes before you’ve got an average of 3%? 37 quarters. On average, over the medium term of 37 quarters, we hit below 3%.

    Just download their Jun08 excel sheet, then plug in a new column that’s nothing but if statements on averages:
    =if(average(E52:E74)<3,23,if(average(E51:E75)<3,25,…..)
    Centred around current quarter: the medium term is 37 quarters if we define the medium term as being that period of time necessary for inflation to be within the 1-3% band.

    The largest prior window was 13 quarters back in September-December 2005.

    If this is not grounds for immediate dismissal of the Reserve Bank Governor, then the whole thing is a complete crock. To paraphrase DeLong, Impeach Bollard. Impeach Bollard Now.

  • CPW

    I thought the RB’s claim that they “still expect inflation to return comfortably inside the target band over the medium term” [emphasis added] was a joke.

    I would note though that the Bank’s interpretation of their mandate now is just “aiming to have projected inflation comfortably within the target range over the latter half of our three-year projection period” (p7 of today’s MPS). So effectively, if it’s back under three some time in the distant future they’re OK.

  • I’ve heard 7 percent unemployment by early ’09 mentioned by people in the business.

  • “I’ve heard 7 percent unemployment by early ‘09 mentioned by people in the business.”

    One thing to remember with that is that business’s are probably looking at the level of employment rather than the unemployment rate. Strangely enough there is a significant difference.

    Businesses may feel that we have a situation where employment levels need to fall. No even if this is the case at an aggregate level, the most likely places there will be reductions in employment are through part-time earners.

    As many part-time earners are students or secondary earners they often do not become unemployed when they lose their job, they “leave the labour force”. If this is the case we would expect a decrease in the participation rate to pick up a significant amount of the decrease in employment.

    An unemployment rate of 7% will also come with a significant (e.g. 5 percentage point) decline in the participation rate – suggesting that there would be a much more significant decline in employment.

    As a result, I find even the 6% level unrealistic.

  • Link’s gone, Matt. I see what you’re saying, but my source takes this into account. I’ll confirm with them on that figure tomorrow, and can be more specific but off the record (if that makes sense!)

    Moles in other sectors of Wellington give the impression of a Wile E Coyote treading air over the canyon. I think we’re in for a hell of a correction.

  • Danged link, here it is:

    http://www.westpac.co.nz/olcontent/olcontent.nsf/content/FM_Bulletin_200
    80605/$FILE/RBNZ_MPS_Review.pdf

    “I think we’re in for a hell of a correction.”

    We are in for a large correction – but obviously the income is still there even in the RBNZ’s case, they just have people increasing their savings markedly. What’s driving that?

    Furthermore, the terms of trade reversal they have just seems over-cooked (given that it stems from a reduction in export prices) – you take that out and the picture would improve significantly.

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