The Reserve Bank reduced its Official Cash Rate last month by 50 basis points to 2.5 per cent.
Peter Nicholl
The bank was widely congratulated and many commentators thought they should reduce the Official Cash Rate by another 25 basic points at their next Official Cash Rate meeting later this month.
I think the Reserve Bank’s approach is risky for two reasons. First, inflation in New Zealand is not yet under control. The September Consumer Price Index number came out recently. It was 3 per cent, right at the top of the Reserve Bank’s target range. The Reserve Bank has eased monetary policy significantly even though they predicted, correctly, that inflation would rise.
That was their first mistake. They said that they expected this increase in the Consumer Price Index ‘to be transitory’ – that the Consumer Price Index would come back within their target range quickly.
They have said this before – and got it wrong. I think this will be their second mistake. Food prices are still rising by around five per cent per a year, power prices, rates and insurance are all still rising by even more. There are a number of large wage claims still unsettled. Our exchange rate is continuing to fall, which adds to import prices.
My second reason is that the Reserve Bank is taking a much more benign view of global inflation risks than most other central banks. In December last year, the Reserve Bank’s Official Cash Rate was 4.25 per cent, which was equal to the policy interest rate in the United States and similar to those in Australia and the United Kingdom. Since then, the Reserve Bank has reduced its Official Cash Rate by 1.75 per cent. Australia and the UK have reduced their’s by 0.75 per cent and the US by only 0.25 per cent.
Yet New Zealand’s inflation rate is currently higher than in the US or Australia. With interest rates in New Zealand now being significantly below those in the US, Australia and the UK, our exchange rate is likely to keep on falling.
The Reserve Bank
The Reserve Bank pre-announces the dates on which they will take their Official Cash Rate decisions. They have announced the next nine dates, all the way out to February 17, 2027. The economy doesn’t move in a smooth fashion and when it is the right time for the Reserve Bank to act can’t be determined in advance.
The timing of the next Official Cash Rate decision on November 26 illustrates this. Five days later Anna Bremen will become the new governor.
The gap between Official Cash Rate decisions is usually six to eight weeks. But this summer the gap will be 12 weeks – all the way to February 18, 2026. The Reserve Bank has already taken a risk by significantly lowering its Official Cash Rate at the same time as inflation rose to the top of the target range.
If the bank lowers the Official Cash Rate further this month, as most economic commentators are proposing they should do, the new governor could have a difficult start to her tenure.
