Reserve Bank believes ‘mechanistic’ OCR model may have confused market

Saturday, 25 May 2024

Reserve Bank chief economist Paul Conway says the central bank may change the way it sets out its expectations of future interest rates, after appearing to confuse some analysts in its latest monetary policy statement on Wednesday.

Conway described the tool the bank uses to generate its interest rate track, setting out expectations of future interest rates, as useful but “mechanistic”, appearing to suggest it may have led to analysts viewing its messaging as more hawkish than intended.

“I am thinking that we do need to have a bit of a think about how we communicate ‘central prediction’ versus uncertainty. Maybe we do need to be a bit more strategic given market sensibilities,” he told The Post in an interview.

Options include the bank setting out a range of possibilities for future interest rates, based on different scenarios that could unfold in the economy, or overlaying a human interpretation on the forecasts output by its modelling tool.

The bank surprised financial markets on Wednesday when it published a “forward track” for the official cash rate (OCR) that implied it would not start to ease monetary policy until deep into the second half of next year.

The forecast also predicted the OCR would average about 5.7% in the final three months of this year, leading some commentators to conclude it was now signalling that a further interest-rate hike was likely.

The monetary policy statement prompted currency traders to push up the value of the New Zealand dollar by half a US cent and caused BNZ to push back its forecasts for rate cuts from November to February next year.

But Reserve Bank governor Adrian Orr later rubbished suggestions at a media conference that its forecasts meant there was a strong chance of a rate hike.

BNZ research head Stephen Toplis said in response that it was “not at all clear what the bank thinks”.

“In its post-match press conference, we were told that the bank’s published rate track was the ‘base case’, implying a 60% chance of a rate hike. We were also informed that ‘raising rates was a real consideration’.

“But to confuse matters it was suggested that we should be sceptical that the track implied a rate hike.”

Putting a fresh overlay on the bank’s comments, Conway confirmed there was “more upside risk to inflation” over the next couple of quarters than the bank had expected when it issued its previous monetary policy statement in February.

But he described the changes to the risks in its outlook as “slight”.

“I don’t see it as a huge shift.”

The most troubling aspect of the bank’s monetary policy statement was that it suggested inflation and interest rates could stay higher for longer not because of any unexpected strength in the economy, rather the bank marginally upped its forecasts for unemployment and downgraded its growth projections.

Instead, the mild double-whammy reflected the expected impact of low productivity growth and “sticky” inflation for some hard-to-target services such as rates, insurance and rents.

Orr said on Wednesday that low productivity growth was “weighing on the potential economic growth of the country”.

“We are operating with a vehicle that can move slower, on average, without generating inflation.”

An appearance by Orr and Conway in front of Parliament’s Finance and Expenditure select committee on Thursday was dominated by that concern.

Government members of the committee probed the pair on whether reduced regulation and red tape could turn the situation around.

But Orr and Conway have in recent days put more blame on other possible factors such as a low level of capital investment by businesses, a lack of competition in parts of the economy, management quality and a lack of investment in “skills”.