Thursday, 12 December 2013

No surprises from the Bank

I'll summarise quickly because the media and the bank economists are already all over it, but the guts of this morning's Monetary Policy Statement from the Reserve Bank was straightforward and as expected: "it is becoming unnecessary to maintain the OCR at 2.5 percent, with GDP growth becoming increasingly self-sustaining. The Bank's assessment is that ... growing demand and inflation pressure should warrant a withdrawal of stimulus beginning in 2014" (p5). The Bank's forecasts have the 90 day bank bill rate rising from 2.7% currently to 3.8% by this time next year and to 4.6% by December '15.

Rising interest rates might sound like bad news (at least to borrowers), but let's note the big picture, which is a strong economic outlook. Here's the Bank's forecast for unemployment.

Anything interesting in the details?

A few things. The Bank reckons that its LVR loan restrictions will take between 1% and 4% off the rate of house price inflation - okay, that's a wide and uncertain band, and it's early days, but if we take the mid-point as a guess, 2.5% off house price inflation is a pretty big impact.

The Bank also played with a scenario where world commodity prices don't actually come off their current high levels, but hold up and even press on a bit more (see Box C on pp24-5). Good news for New Zealand, sure, but a mixed bag for the RB. Higher incomes from fancy export prices boost the economy and domestic inflation pressures (bad news for the RB) but the high commodity prices also likely lead to a higher Kiwi dollar (which restrains the economy and dampens inflation, good news for the RB). Net effect? The net upward pressures on inflation mean that interest rates would need to rise more than the RB currently plans, as shown below.

While it's mostly a benign outlook, there's still one thing that bothers me. I've blogged about it before, but here it is again in its latest version.

It's that forecast for non-tradables inflation, the cost pressure that arises in those parts of the economy not facing import competition. Yes, you'd expect it to pick up as spare capacity gets used up: that's an understandable cyclical process. But it might also rise for structural reasons: inflexibility, insufficient domestic competition, a 'cost plus' mentality. If we do get lumbered with domestically sourced inflation of close to 4%, let's hope it's wholly or largely cyclical.

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