The Reserve Bank announced on Wednesday that it was holding the Official Cash Rate at 1 percent when bank economists had widely predicted and recommended a 25 basis point cut, Marc Daalder reports
The Reserve Bank’s decision to hold the OCR at 1 percent was a surprise to economic observers, who said the almost five-year-low inflation expectations announced yesterday appeared to seal the deal on a 0.25 percent cut.
The decision comes as economists and the Reserve Bank itself have called for more fiscal stimulus from the Government, which has been reluctant to borrow more and spend more despite relatively low net debt and a $7.5 billion operating surplus for the 2018 financial year.
The New Zealand Dollar, which had slumped ahead of an expected cut, rebounded from 63.33 cents on the US Dollar to 64.10.
Orr explains his decision
The economy is slowing down due to both global and domestic pressures. Internationally, central banks have cut steadily, with the Reserve Bank of Australia cutting rates to 0.75 percent in October. The United States’ Federal Reserve cut rates for the third time this year on October 30.
Governor Adrian Orr has instead charted a more erratic path, cutting by 50 basis points in August when a more modest decrease was expected and now holding the line at 1 percent. In its Monetary Policy Statement, the Bank wrote that the Monetary Policy Committee “agreed that the reduction in the OCR over the past year was transmitting through the economy and that it would take time to have its full effect”.
“The Committee debated the costs and benefits of keeping the OCR at 1.0 percent versus reducing it to 0.75 percent. The Committee agreed that both actions were broadly consistent with the current OCR projection.”
As the interest rate gets lower and lower, further cuts will struggle more and more to make a difference, observers say. The next steps if it hit zero for the Reserve Bank, if the Government fails to step up with sufficient fiscal stimulus, would be unconventional. Orr told reporters in August that the Bank was actively investigating the possibility of quantitative easing or a negative OCR, though he kept mum on the more radical idea of helicopter money.
In the MPS, the Bank reiterated this. “The Committee noted the Bank’s work programme assessing alternative monetary policy tools in the New Zealand environment, as part of contingency planning for an unlikely scenario where additional monetary instruments are required.”
Choosing not to cut now also means that the OCR will hold where it is until at least February 12, 2020, when the next OCR decision is to be made.
Fiscal stimulus seen as sufficient
Orr had previously indicated that the Government needed to ramp up fiscal stimulus, putting Finance Minister Grant Robertson on the back foot. Robertson repeatedly defended the Government’s programme and the Bank appears to have come around.
“Many countries have suggested that monetary policy tools may be secondary to some of the fiscal policy tools. We’re not in that position at the moment but we always like to have friends.”
In the latest MPS, the RBNZ wrote, “The members anticipated a lift in economic growth during 2020 from the easing of monetary policy that has taken place since early 2019 and from stronger fiscal stimulus. The Committee discussed the impact of fiscal stimulus on the economy. The members noted that fiscal stimulus could be greater than assumed.”
Through 2020, the RBNZ expects the Government’s fiscal policy will pull its weight. “Fiscal stimulus and low interest rates are expected to support stronger growth over 2020,” it wrote.
After Budget 2019 runs its course, however, there are worries regarding whether the stimulus will continue. “Based on spending plans in Budget 2019, government consumption growth is expected to increase sharply over the second half of 2019,” the MPS stated. “Growth in spending slows in 2020 and continues at a low level over the rest of the projection period.”
At a press conference on Wednesday, Orr once again brought up the need for fiscal stimulus, even as he conceded that the Government’s spending was projected to support further growth. “Many countries have suggested that monetary policy tools may be secondary to some of the fiscal policy tools. We’re not in that position at the moment but we always like to have friends,” he said.
Orr declined to outline specifically what sort of long-term Government investment he would like to see. “That’s not our job, they will do what they do and we have made our message very clear,” he said.
“Meanwhile, we will continue to do whatever it takes with our tools.”
Prior to the decision, Robertson reiterated that the Government was doing enough on spending. “I think the economy’s in pretty good shape. We’ve got a budget where we significantly increased both operating and capital spending. That’s rolling out now,” he said.
However, Robertson also left the door open for more stimulus, if needed. “We’ll always continue to look for opportunities to do as much as we can in the economy to help with productive growth,” he said.
Inflation expectations seemed to signal cut
While observers had been split on what the RBNZ would do in the weeks leading up to Wednesday’s decision, the Tuesday release of the RBNZ’s own Nielsen survey of inflation expectations seemed to seal the deal for a cut.
The survey showed a fall in expectations over the next two years to 1.80 percent, from 1.86 percent in the September quarter – the lowest expectations have been in four-and-a-half years and a considerable drop from 2.01 in June.
Deflating expectations indicates that the Reserve Bank’s massive OCR cut of 50 basis points still wasn’t enough to move the needle significantly.
Speaking in August after that decision, Orr said inflation expectations were a major driver. “We saw our own inflation expectations starting to decline and we didn’t want to be behind that curve. We want to keep inflation expectations positive – near the mid-point of the band,” he said.
However, Orr brushed off concerns about inflation expectations on Wednesday.
The Monetary Policy Statement “noted the slight decline in one- and two-year ahead survey measures of inflation expectations. Nevertheless, long-term inflation expectations remain anchored at close to the 2 percent target mid-point and market measures of inflation expectations have increased from their recent lows.”