Economy

RBNZ chilled on virus, but not on wages

The Reserve Bank is both chilled and wary at the same time: relaxed about the coronavirus hit for now, and slightly worried wage inflation might be about to take off. Bernard Hickey analyses the bank's decision not to deliver an 'insurance' interest rate cut.

On Thursday, the Kiwi dollar was up more than half a cent after the Reserve Bank was relatively sanguine about the coronavirus hit and left monetary policy on hold. It also lifted its interest rate forecast track a bit and noted the housing market rebound was boosting household spending.

It also liked the Government's extra fiscal stimulus and said it was one reason it could afford to wait and see how bad the coronavirus gets.

Just a sneeze. Not a flu - The Reserve Bank held the Official Cash Rate at 1.0 percent, as most economists had expected, but it was more upbeat than some expected and nudged its interest rate forecasts up a bit. That, in turn, helped boost the New Zealand dollar around half a cent towards 65 USc.

It forecast the disruption to the global and local economies from the Wuhan coronovirus outbreak would ease by mid-March and forecast a 0.3 percent reduction in New Zealand's GDP growth in the first quarter.

Other economists have projected a GDP hit of up to 0.7 percent, with many around the 0.5 percent mark.

Plenty of pep

The Reserve Bank noted extra stimulus from the Government and extra spending from home-owning consumers would boost GDP growth back to 3.1 percent in the December quarter of this year, before it eased off back to near 2.0 percent late next year.

However, there's a caveat. The forecasts were finalised on February 5, which was three days after the start of the ban on visitors from China was started.

The Reserve Bank said it believed the worst of the coronavirus would have passed by mid-March with visits and flights from China resuming by then after a six-week hiatus.

Adrian Orr was asked why the bank chose not to deliver an 'insurance' cut to the OCR.

"There are a lot of reasons why we have time to hurry up and wait," he said.

Party pooper...

The bank warned that the economy might be operating faster than its employment limits and said some committee members were worried about the potential for further upward wage pressure.

"The members discussed the contribution of the tight labour market to wage pressure and any flow on to consumer price inflation, and noted the effects of recent minimum wage increases, pay equity settlements, and large collective agreements in public sector," the bank said in its MPS.

Here's the chart with the data in the document.

Why it matters

This was the first time since the arrival of a new Governor, a new Monetary Policy Committee and the election of the Labour-New Zealand First coalition Government in late 2018 that the Reserve Bank had started talking tough about wage inflation, which has surprised most (including the Reserve Bank) with its weakness over the last decade.

It's the first time in a long time I've heard warnings like that of last three decades against big pay hikes.

The culture of the Reserve Bank and Treasury was forged in the inflation-fighting era of the late 1980s. It has regularly warned about the re-awakening of the inflation dragon, but it has held back from such warnings in recent years because wage inflation has turned out weaker than everyone expected.

Should the Reserve Bank be worried?

It's hard to see a break-out of wage inflation in the private sector beyond the effects of the big minimum wage increases over the last two years. Yet. Most of the big pay rises have been in the public sector and arguably linked to one-off changes around pay equity.

It's worth remembering that over the last decade the Reserve Bank, along with everyone else, has constantly under-estimated the ability of the economy to grow without re-awakening the inflation dragon.

It was essentially too hawkish for a decade. That has meant it has under-estimated the productive capacity of the economy, and over-estimated the inflationary impact. That has meant it has run monetary policy tighter and kept interest rates higher than it would otherwise have done to keep inflation around 2.0 percent.

The bottom line

The key thing to look at in any Reserve Bank Monetary Policy Statement is its forecast for the Official Cash Rate (below), which is what is spat out the end of its modeling once it has worked out what is happening to inflation, growth, wage, global and market pressures, and what it needs to do with interest rates to keep inflation around two percent.

The bank lifted its forecast OCR track just marginally, and essentially took out a small 'placeholder' cut later this year, as this chart shows. It still sees rates eventually rising back towards some neutral level closer to 2-3 percent around 2023.

My view?

Let's hope the Reserve Bank is right about coronavirus. But I think the bigger picture is continued downward pressure on inflation and interest rates because of the epic changes happening very quickly in how we use and buy services globally through our phones and the Internet.

I still think we'll see the OCR closer to 0 percent than 1.0 percent in the next couple of years.

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