New Zealand's no-nonsense approach to monetary policy
The Reserve Bank of New Zealand tightened monetary policy yet again at its July meeting but is set to put its policy lever on hold for a few months as it assesses the economy’s response to tighter policy. With activity remaining strong and the outlook bright, it surely won’t be long before it raises rates again.
The cash rate in New Zealand will rise by 25 basis points to 3.5 per cent following the RBNZ’s decision to tighten monetary policy. Rates have been tightened by 100 basis points since the RBNZ began raising rates in March.
But that might be it for now, with the RBNZ keen to see the impact that its moves have made.
“Encouragingly, the economy appears to be adjusting to the monetary policy tightening that has taken place since the start of the year,” RBNZ governor Graeme Wheeler said. “It is prudent that there now be a period of assessment before interest rates adjust further towards a more-neutral level.”
In language that would be welcome at our own central bank, Wheeler noted that in light of declining commodity prices, “the level of the New Zealand dollar is unjustified and unsustainable and there is potential for a significant fall”. I’ll admit I like the no-nonsense approach from our Kiwi brethren.
If sustained, the fall in export prices for dairy and timber will begin to weigh on income growth and provides a modest downside risk for the broader economy. But while a strong terms of trade has been the icing on the cake, it is New Zealand’s construction sector that will continue to drive growth over the next couple of years.
The task for the RBNZ is simple: create sufficient spare capacity within the non-construction sector to allow the rebuilding of Christchurch and Canterbury without creating an outbreak of inflation across the broader economy. The construction sector will need to call on resources such as credit, capital and labour from the rest of the economy to facilitate the rebuild.
The Reserve Bank of Australia faced a similar problem when it raised rates 175 basis points from October 2009 to November 2010 to create room for the mining investment boom. The risk of such actions is that the sectors of the economy that aren’t booming may in fact go the other way, resulting in a loss of competitiveness and capacity utilisation from which it may be difficult to rebound.
Net migration remains elevated but the RBNZ expects that it will moderate somewhat over the coming years as conditions in other countries, particularly Australia, improve. But in the meantime, this should support residential investment, in addition to the demand driven by the Canterbury rebuild.
Inflation remains moderate in New Zealand -- which is precisely why the RBNZ can take a break and assess conditions -- but strong growth continues to consume spare capacity across the economy. Over time this may result in wage growth breaking out and contributing to higher inflation for non-tradable goods.
If Wheeler is right and the New Zealand dollar is at an unsustainable level, then that too will put pressure on inflation and may necessitate further action by the RBNZ down the track.
Growth remains strong in New Zealand but, by virtue of the Canterbury rebuild, it isn’t necessarily broad-based. That will be exacerbated by further fiscal consolidation over the next couple of years.
I expect that standards of living will improve significantly for those exporting goods to China (although the Chinese economy presents its own set of risks) and the construction sector, but it will be much harder going for other sectors of the economy.