Reserve Bank expected to stay on course on Wednesday as winds shift

Monday, 24 May 2021

Reserve Bank former chief economist, John McDermott, explains how inflation is measured and how it manifests itself.

Markets will be watching the Reserve Bank’s monetary policy statement on Wednesday for signs it now expects higher growth and inflation and might ‘tighten’ earlier than expected, economists say.

BNZ research head Stephen Toplis said the central bank was in a very difficult position as the market was now at a turning point and the bank would not want to trigger an overreaction.

“Nobody would really argue there was as much chance of them easing further as there is of them tightening.”

Toplis said it was hard for the bank not to acknowledge developments, but it would also know it had time before it needed to do anything.

The Reserve Bank is not expected to alter any of its monetary settings and to leave the Official Cash Rate at 0.25 per cent.

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“What we will be looking for is to see how the Reserve Bank interprets what is definitely a stronger labour market than they had expected and probably a more inflationary environment,” Toplis said.

BNZ would also be looking at any assessment the central bank made of the “unconstrained OCR track”, which Toplis said was often overlooked.

That rate is the Reserve Bank’s estimate of the total monetary stimulus needed to best meet its mandate.

ANZ chief economist Sharon Zollner said the Reserve Bank would be careful to hedge its scripted comments.

“They are going to stick to the same line saying ‘stimulus will be required for a long time and it is very uncertain’, and so on.”

But the Reserve Bank would follow the Treasury in revising up its forecasts for growth, employment and inflation, she predicted.

“The markets may well chose to focus on changes to their forecasts.”

Jarden senior economist John Carran expected the Reserve Bank to revise up its forecasts for growth and perhaps for short-term inflation.

But he expected the bank would stick to the line that it expected inflation to drop back later.

“Often what causes a reaction, more than their words, is the track of their forecasts,” he said.

“If the unconstrained OCR shows any measurable change or lift, that could potentially excite markets to a degree.”

The Reserve Bank would need to say something about the housing market, due to the new framework it was working under, Carran said.

“But I think it will be that they are ‘watching carefully’ and that it is still too early to say what recent measures will do.

“They just have to show they have given it consideration and they are reflecting on its impact on the economy.”

The Treasury forecast in the Budget that inflation would peak at 2.4 per cent and unemployment at 5.3 per cent in the September quarter, before falling back.

But Toplis said BNZ was forecasting inflation to exceed estimates and for unemployment to come in lower.

There appeared to be some consistency issues in the Treasury’s forecasts, for example with regard to a “heroic” prediction for strong productivity growth, he said.

“We have had basically no growth in productivity for the last four or five years, so where did that come from?”

Zollner reiterated there was a risk inflation could become persistent.

“It is not just cost increases; we are facing shortages of goods such as building materials that actually reduce the ‘speed limit’ of the economy and affect the outlook for medium-term inflation,” she said.