Reserve Bank’s comments on GDP and inflation-drop mask a darker warning

Wednesday, 31 January 2024

ANALYSIS: Anyone hoping an address by Reserve Bank chief economist Paul Conway on Tuesday would signal the bank was pivoting away from its recent hawkish commentary towards an early reduction in interest rates will have been disappointed.

Conway didn’t shy away from making some meaningful comments on recent economic data during a highly-anticipated webinar on Tuesday.

Indeed, he fronted-ended his address by commenting in quite direct terms on recent weak GDP data and seemingly more benign inflation data.

But his message was that the former did not necessarily imply capacity and inflationary pressures in the economy were any less than previously thought.

And there was no surprise that he pointed to the devil in the detail of the big drop in inflation reported by Stats NZ last week.

Being just one member of the Reserve Bank’s monetary policy committee, Conway doesn’t really have the remit to set interest-rate expectations on a new path.

But unrealistic expectations about Conway what might reveal on Tuesday in relation to the fresh economic data may have taken attention away from a troubling message from the Reserve Bank’s top economist.

The drop in annual inflation to 4.7% reported by Stats NZ in the December quarter was primarily due to a 0.2% quarterly fall in the price of imports and other goods and services who prices are largely determined overseas.

But Conway is clearly concerned that the Reserve Bank can no longer count on a long-term relative decline in those so-called “tradeable goods and services” helping the bank meet its inflation targets over the long term.

This isn’t an entirely new message from the Reserve Bank, which has previously suggested that the era in which economies can rely on cheap Chinese manufacturing to dampen inflation is drawing to a close.

But, on this occasion, Conway flagged a broader concern that supply shocks to the economy caused by geopolitical events — wars, protectionism, populism, perhaps — could become “larger, more frequent and persistent” over the coming decades.

“As the global economy splinters into blocks of politically-aligned countries, globalisation may become less of a disinflationary force than it has been,” he warned.

“This means we should not expect substantial declines in imported inflation to achieve our inflation target. Instead, home-grown, or domestic inflation, would need to be lower than it has been historically.”

During the height of the Covid pandemic, the Reserve Bank made it very clear it would “look through” (meaning essentially ignore) what it assumed was a spike in tradeable inflation caused by production and logistics problems.

But Conway queried on Tuesday whether it would still be appropriate for central banks to look through such shocks in a situation where they became more the norm.

That may not be the top concern for borrowers right now, in the current situation where tradeable inflation has fallen below zero.

But it suggests that if the price of petrol or other imports spike, for example because of logistics problems caused by the tensions in the Red Sea and traffic restrictions on the Panama Canal snowballing into a wider logistics snarl up, then that could feed through faster and more fully into the official cash rate.

Sure, you could argue whether the Reserve Bank’s newly more-hurried obsession with driving down inflation to the mid-point of its 1% to 3% target band was optimal.

But given its ambition appears to be what it is, Conway’s speech left both ANZ chief economist Sharon Zollner and BNZ research head Stephen Toplis warning of a residual risk of a rise in the official cash rate to 5.75% on February 28.

No cause for relaxation from recently-released economic data in the short-term and more to worry about in the longer term as a result of geopolitical woes; there was no comfort for borrowers in Conway’s address.