The Reserve Bank’s monetary policy statement this week gives scant support to those inclined to scaremonger about inflation.
The bank expects consumer price inflation will peak in the middle of this year at 2.6 per cent — for reasons that are transitory and which it should disregard — and will have fallen back into the bottom half of its 1 to 3 per cent target band by the March quarter next year.
Nevertheless, it is sufficiently nervous about the risk of wage inflation over the medium term to pencil in a start to official cash rate rises in the September quarter next year. It projects the OCR to rise from there until by early 2024 it is back to the less-than-vertiginous heights it was at two years ago, 1.75 per cent.
Governor Adrian Orr stressed that this projection is conditional on some key assumptions.
One is that expectations of a stronger global recovery are realised. That, in turn, is conditional on “containing” a virus which is still spreading, mutating and killing people in large numbers.
The bank expects border restrictions to ease from early next year, easing labour shortages.
It expects supply chain disruptions to begin to ease later this year and dissipate gradually over 2022.
It expects house price inflation to fall swiftly to near zero in quarterly terms from the middle of this year.
And its forecasts include the Budget’s plans to boost spending, which the bank sees as helpful burden-sharing.
With all those fingers crossed, the monetary policy committee has decided to maintain its current stimulatory monetary settings “until it is confident that consumer price inflation will be sustained near the 2 per cent per annum target mid-point and that employment is at its maximum sustainable level”. Previously, it had said “at or above” its maximum sustainable level.
It says attaining that confidence will require “considerable time and patience”.
But it is evidently willing to run the risk of tightening ahead of the two central banks that are most relevant to us.
The Reserve Bank of Australia says it will not increase its cash rate until actual inflation is sustainably within its 2 to 3 per cent target range — not looks like it will be — while the US Federal Reserve says it is on hold until inflation is “on track to moderately exceed 2 per cent for some time”.
New Zealand’svaunted “resilient” labour market is not as robust as headcount measures would suggest.
While it is welcome that the number of people employed has returned to March 2020 levels, that masks a decline in hours worked, an increase in the number of part-timers and a marked increase in the under-employed — part-timers who want to, and could, work longer hours — as well as broader measures of labour market slack.
The bank says that employment is closer to, but still below, its maximum sustainable level.
The problem is that that level, it reckons, has declined since the pandemic struck. “The skills of those who lost their jobs in industries such as tourism are not necessarily well matched to sectors demanding more workers.”
It notes that wages, as reflected in the private sector labour cost index, barely kept pace with inflation in the year to March.It expects wage growth to strengthen over the year ahead, reflecting continuing labour shortages and last April’s increase in the minimum wage, and to outpace CPI inflation over the next three years.
But would some real wage growth be such a bad thing?
The Reserve Bank is likely to continue to scale back its purchases of government bonds under its quantitative easing programme, just as the Treasury has scaled back its expected issuance. That would continue the trend which has seen bond purchases decline steadily from an initial $21 billion in the June quarter last year to $6.8b in the March quarter this year.
It would not per se represent a tightening.
In recent months the wholesale interest rate curve has steepened markedly as yields on longer-dated bonds — which tend to be driven by international bond markets — rather than the Reserve Bank, have climbed.
That reflects concerns offshore about inflation risk and a belief that central banks are being too sanguine about it.
It is inevitable that inflation will increase as pent-up demand from prolonged lockdowns runs up against disrupted supply chains.
It is not obvious, however, that the central banks are wrong to expect those effects to be transitory rather than the persistent kind which threatens to lift inflation expectations to levels they would want to curb.
While it is frustrating to have delays, bottlenecks and skyrocketing charges in container shipping, for example, it is not as if U-boats have sent much of the merchant marine fleet to the bottom.
And on the demand side, there are the scarring effects of a serious recession, like the fact that there are still 8 million fewer Americans employed than there were pre-Covid.
There seems to be a kind of amnesia in the markets. It is not that long ago that the question about inflation was why it was so stubbornly low and resistant to efforts by central banks to push it up towards the 2 per cent level they consider ideal.
The debate was about what long-term trends have been driving that.
Is it demographics, as ageing baby-boomers have got more serious about saving?
Is it globalisation, driving down the embedded labour costs in manufactured goods?
Is it information technology making it easier, for example, for consumers to compare prices and strengthen competitive discipline on firms’ pricing power?
Or (d) all of the above?
It is not as if the coronavirus has killed those trends off.
As for New Zealand-specific factors, there are reasons to expect the demand side of the economy to be weaker than it was before Covid struck.
Population growth was rapid, largely driven by rates of net immigration greater than the economy could accommodate, literally.
The Government sounds as if it wants to throttle that back, while allowing firms to recruit the skilled workforce they need.
Getting that balance right will be tricky and the policy settings which emerge will affect both the supply and demand sides of the economy, but the net effect may prove disinflationary.
Another factor underpinning demand has been the wealth effect from runaway house price inflation as homeowners spend a few cents in the dollar of the increase in their housing equity. The road spikes rolled out in its path by tax changes and the Reserve Bank’s macro-prudential policy ought to diminish that, or even reverse it.
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