Orr says Reserve Bank getting towards point where next rate move not obvious

Thursday, 18 August 2022

Reserve Bank governor Adrian Orr says increasingly diverse opinions about where the bank should set interest rates are a pleasing sign, as that would suggest the bank must be getting close to the point where its next decision is getting really hard to make.

The Reserve Bank raised the official cash rate by 50 basis points to 3% on Wednesday and noted in its monetary policy statement that its monetary policy committee had discussed whether “more rapid increases could improve the credibility” of its inflation targeting.

ASB chief economist Nick Tuffley said on Wednesday that he took that as a flag of where the Reserve Bank “saw the risks around the OCR at the moment”.

But Orr said the committee also discussed the merits of a 25bp rate rise, which credit ratings agency Moody’s had suggested might be sufficient to tame inflation given its own assessment that global inflation pressures were dissipating and there was evidence of slowing consumer demand.

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Diversity of opinion over the size of the rate rise that was required would suggest that monetary policy settings were getting close to where they needed to be, Orr said.

“I think it was Mervyn King, the governor of the Bank of England at the time who said if the next step was very obvious, it means you're in the wrong place now.”

Orr suggested the bank had had some very obvious steps in front of it.

“We've gone from very loose back to something that's tighter.

“It's been very evident in global markets that the bond markets are busy trying to price the end of the current tightening period already internationally and look for ‘sunshine’.”

The Reserve Bank had started raising interest rates before other central banks and “who knows, we might be able to be more successful and complete our tightening phase ahead, so we need to take those views on board and think about them,” he said, referring to Moody’s commentary.

At present, however, the Reserve Bank is forecasting the OCR will rise to 4% next year and stay at that level until late the following the year.

Orr said he felt himself that the bank was moving towards the point where it didn’t necessarily know what its next moves were going to be.

“I feel we are getting there. At 3%, at the moment; not far enough above broad estimates of ‘neutral’; that’s why we're saying, you know, possibly up to 4%.

“But beyond that we are saying that is unambiguously north of neutral, that gives us time to watch, worry and wait and observe how things are panning out over time. If we got our tightening done over that period, I think we'd be pretty pleased.”

The Reserve Bank’s current more ‘hawkish’ phase comes in the wake of criticism from former governor Graeme Wheeler and others that it and many other central banks were too loose in the earlier stages of the Covid pandemic, particularly with respect to its $54 billion spend on quantitative easing.

Orr confirmed on Wednesday that the bank would conduct a scheduled review of its policies over the five past years and said it had contracted the former deputy governor of the Reserve Bank of Canada, Lawrence Schembri, and Australian economist, Warwick McKibbin, to provide independent input.

The Reserve Bank of Canada pursued policies that were similar to those of New Zealand’s Reserve Bank during the pandemic, but McKibben has been a vocal critic of many of those policies, including quantitative easing.

National Party leader Christopher Luxon has pushed for a fully independent review of the Reserve Bank’s actions, but Orr said the bank was following the process that was set down in legislation and the question of whether an independent review was merited was not its call.

“That's the call of our political masters,” he said.

Orr said he didn’t know if the bank had the authority to order such an independent review off its own bat, while saying its own review was “putting everything on the table”.

“One would hope that might satiate desires, or that may even increase desires for additional reviews and at that point we’ll see what happens,” he said.

Orr said one of the main questions the bank aimed to answer was whether – given the information it had at the time – it made the decisions that were consistent with meeting its remit.

The bank admitted in a paper on Thursday that the fact inflation was now outside its target band, running at 7.3%, showed “with the benefit of hindsight” that monetary policy was too stimulatory at some stage during the pandemic.

“Did we overuse the tools? Did we ease by too much or did we stay easy for too long? That's a real possibility,” Orr said.

But the bank’s paper also said international financial institutions and “virtually all other forecasters” had been predicting extremely serious and persistent negative consequences for the global economy from the pandemic.

“Deep recessions, double-digit unemployment rates and entrenched deflation were commonly seen as plausible scenarios in the absence of significant monetary and fiscal policy support,” it said.

Orr denied the paper prejudged the outcome of its review.

“We're not prejudging outcomes. We're trying to help [fulfill the] insatiable desire for knowledge in real time.

“We are bending over backwards to be transparent and show that we truly care about our mandate and remit,” he said.