Achieving 2% inflation on any given day ‘impossible’, but vital public believes in the target

Friday, 16 February 2024

Reserve Bank governor Adrian Orr has avoided dropping hints on whether the central bank could raise the official cash rate when it releases its first monetary policy statement for the year on February 28.

But speaking to an economics forum hosted by Waikato University, Orr strongly emphasised the importance of making sure people had “trust and confidence” in the bank’s ability to return headline inflation to its target of 2%.

Orr said recent research by the bank confirmed that it took between 18 months and two years for a change in the official cash rate (OCR) to have its “peak, maximum impact” on inflation.

That, transient inflation, and the fact the bank was often working off economic data such as GDP estimates that were released with a “significant lag”, meant achieving a 2% inflation target on any specific date with precision was “impossible”, he said.

“If you were trying to do that you would be putting the economy through ridiculous uncertainty, volatility and variability and you still wouldn’t succeed.”

But the bank had to be trusted by the public that it was focused on achieving its inflation target, he said.

“Making sure that inflation expectations don’t get ‘baked in’ is the core task for the Reserve Bank.”

The bank’s “number one” concern would be that people might lose confidence it was aiming at the 2% target with real “vim and vigour”, he said.

In a potentially encouraging sign for borrowers, the bank reported on Monday that people were expecting inflation to drop to 2.5% in the medium term.

That was a significant improvement on the results of a survey late last year that put the medium-term inflation expectation at 2.8%.

Orr said so-called “non-tradeable” inflation, caused by domestic inflationary pressures, was moving in the right direction but more slowly than the drop in tradeable inflation caused by the price of imports and other goods and services whose prices are set internationally.

At 4.7%, headline inflation was “more than two times 2%” and the bank had more work to do to get inflation expectations truly anchored at that 2% level, he said.

“The last few yards may be very difficult because we really need to re-anchor that 2% expectation.”

The Reserve Bank’s monetary policy committee will start meeting on Monday to hear forecasts from the bank’s economists and consider its next move.

ANZ, which took a hawkish stance on the interest-rate outlook for much of last year, has forecast the bank will raise the OCR twice, to 5.75% this month and then to 6% in May.

No other major banks have followed ANZ in that prediction, but expectations that the Reserve Bank might start reducing the OCR as soon as August have recently been on the wane, with most economists now expecting the rate will stay at 5.5% for longer.

Westpac chief economist Kelly Eckhold said this week that financial markets had been more flighty in the last two months, with economic data “quite variable”.

Eckhold said he was very comfortable with its own forecast that the OCR would remain at 5.5% throughout the year before starting to drop in February next year.

ANZ said Orr’s speech hadn’t appeared to have an effect on financial markets.

“This speech was not aimed at impacting financial markets and the governor will likely be chuffed that he didn’t cause a ripple in rates or foreign-exchange markets.”