Thursday, 12 June 2014

The other news in the Reserve Bank's decision

No surprises from the headline decision at the Reserve Bank today - interest rates up again, and likely to keep heading up - but as usual there's all sorts of other interesting analysis in the Monetary Policy Statement.

On the headline front, the Bank's latest interest rate forecast is shown below. If you like numbers rather than pictures, the Bank is picking a 90 day bank bill rate of 4.5% in a year's time (compared to 3.5% as I write), and a further but smaller rise to 5.0% by June '16. The financial futures market currently reckons the Bank won't charge ahead quite as fast as all that - it's picking 90 day bills at 4.25% in a year's time (you can find the futures prices here, subtract them from 100 to get the expected bill yield) - but either way rates are headed substantially higher.

Looking at the rest of the Statement, the Bank said that its current views and plans depend in particular on "export prices, the exchange rate, net immigration, the housing market and construction", any of which could spring a meaningful surprise.

Interestingly, the Bank had a go at quantifying what the uncertainty might look like, with a Monte Carlo exercise of simulating 1000 possible future tracks, based on historical volatility and correlations, and it came up with this as the plausible future range for 90 day rates (it did the same for inflation and the output gap, if you're interested, all on p6). The dark grey bit covers the middle two-thirds of the 1000 outcomes and the lighter grey bit the middle 90% of them.

These 'fan charts' are the in thing around the world's central banks. Here, for example is the Bank of England's equivalent stab at how British GDP might or might not unfold (from its May Inflation Report).

These charts are good reminders of two things - one, how spuriously precise economic forecasts generally are (and are taken to be), and two, how difficult a job central banks (and economic policymakers in general) face in real time. 

While there is clearly uncertainty about the exact scale of future interest rate rises, Joe and Joan Bloggs are onto it. As the Bank noted (p13), "Between the end of January and the end of April, the value of the stock of floating-rate mortgages fell by $10.4 billion while the value of fixed-rate mortgages rose by $9.7 billion, with $5.5 billion of that fixed for two years or more".

Joe and Joan are getting their act together in other ways, too. Here's the Bank's stab at the household saving rate. I'd point out that these data have been revised left, right and centre in the past few years, 'saving' can mean different things, and all in all you're best advised to treat them as indicative rather than holy writ. But they do tend to show a sizeable improvement from what was, probably, an unsustainably unbalanced position. What Joe and Joan have been doing isn't all that unusual - households across the western world have been retrenching and getting themselves into better financial shape - but it's particularly good to see it happening here at home, as we arguably had more fragile household saving than a lot of other places.

And finally an update on my own hobby horse, the state of domestic, non-tradable inflation. Here's the Bank on the situation and outlook for the tradable and  non-tradable components of inflation.

Yes, there's a fair slab of cyclically understandable, Christchurch and Auckland construction-related stuff going on in that non-tradables inflation, and in a perfect world you'd try and disentangle it to isolate the non-construction non-tradable inflation (what the dentist and the school and the local authority and the utilities are charging us). While I haven't done that, what I suspect the exercise would show us if I did is that there's a very stubborn, core rate of domestic inflation (look at how the blue line was behaving even before the Canterbury earthquakes, for example). 

All of our headline inflation is coming from domestic sources, and the only reason the Bank's inflation target hasn't been blown to billy-o is that the high exchange rate has kept imported inflation down. From that perspective, the Bank is absolutely right to set monetary policy to 'tighter', and right to keep ratcheting it up for the next year or two.

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