In today's email we dig into yesterday's monetary policy statement and the surprisingly dovish forecasts from Reserve Bank Governor Graeme Wheeler.
1. Wheeler in neutral
Reserve Bank Governor Graeme Wheeler surprised everyone yesterday with a much more dovish than expected set of forecasts for the Official Cash Rate (OCR).
Wheeler left the OCR on hold at 1.75 percent for the third consecutive time, which was no surprise, but also left the Reserve Bank's forecast track for monetary policy unchanged from its last set of forecasts at the February Monetary Policy Statement (MPS).
That means the Reserve Bank does not expect the OCR to start rising until the second half of 2019.
Many economists had expected the Reserve Bank to shift to a mild tightening stance and bring forward its forecast for the first rate hike to the early-to-mid 2018. The surprisingly dovish statement and forecast drove the New Zealand dollar down almost a cent to 68.5 USc and wholesale interest rates fell around five basis points.
The key quote from the MPS to illustrate the bank's neutral stance was this: "Premature tightening of policy could undermine growth, causing inflation to persistently undershoot the target midpoint. Further policy easing, in an attempt to see non-tradables inflation strengthen more quickly, would risk generating unnecessary volatility in the economy."
Governor Graeme Wheeler's opening statement referring to monetary policy was also unchanged in substance from his last two decision.
Here's the comparison of the key last sentence at the foot of the statement:
May 11 MPS -"Monetary policy will remain accommodative for a considerable period. Numerous uncertainties remain and policy may need to adjust accordingly."
March 23 OCR - "Monetary policy will remain accommodative for a considerable period. Numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly."
February 9 MPS - "Monetary policy will remain accommodative for a considerable period. Numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly."
The only change was to drop the line about uncertainties in the international outlook.
2. Where's the wage inflation?
The biggest surprise for economists was the apparent lack of inflationary pressures bubbling up in the Reserve Bank's forecasts, despite slightly higher than expected CPI inflation in the March quarter and rising inflation in construction and housing.
The Reserve Bank's forecasts actually showed a lower track for inflation in 2018. It saw CPI inflation falling from 2.2 percent in the just completed March quarter to 1.1 percent by the March quarter of 2018 as the recent blips in food and fuel prices drop out of the figures.
The bank does not see CPI inflation returning to the mid-point of its 1-3 percent target band until the June quarter of 2019, which was exactly the same as in its February forecasts.
Wheeler told the news conference in the morning that some in the market suggested that inflation pressures were building up quite rapidly.
"We don't hold that view. We've seen very little impact or very little sign of any acceleration in wage inflation and the same is true in many countries," he said.
Wheeler also pointed to the bank's preferred measure of core inflation, the sectoral factor model, being solid at 1.5 percent, and that inflation expectations were well anchored at 2 percent
"And we have seen a significant slowdown in house price inflation. So all of that suggests we are not going to see a burst of inflation in this economy," he said.
Specifically asked if the bank now had a neutral stance, he said: "We are neutral on monetary policy and for the foreseeable future we would expect the OCR to remain at its current level."
3. The migration effect
Wheeler went further to explain the apparent differences in forecasts between the bank and most economists during his appearance before the Finance and Expenditure select committee, which focused again on the low wage inflation forecast.
He pointed to a variety of factors, including previously low price inflation, low productivity and high net migration of people of working age.
He said 204,000 people of working age had migrated since 2012 and a further 130,000 were forecast by the Reserve Bank to arrive over the three years, which was adding supply to the labour market. That Reserve Bank forecast represents a halving of the run rate for working age migrants, which was challenged by New Zealand First Leader Winston Peters in the select committee as not taking into account likely political changes to migration policy.
Coincidentally, Employment Minister Paul Goldsmith released MBIE's Short Term Employment forecasts report for 2017 to 2020, which forecast 152,000 jobs would be created in the next three years. That would mean that the bulk of the new job creation over the next three years would be soaked up by migration.
If migration does not fall as forecast (and Wheeler highlighted in the select committee that the bank's previous forecasts had been wrong) then all of the forecast job creation would be met by migration.
The MBIE report forecast 61 percent of the job growth would be in highly-skilled occupations, with 40,000 of the jobs being lower skilled jobs. One of the concerns expressed by MBIE and the Government in its recent round of tweaks to migration settings was that many of the migrants were getting lower-skilled jobs.
The MBIE forecast would suggest that the arrival of 130,000 younger migrants to compete for 40,000 lower skilled jobs would continue to keep pressure down on wages at the lower end of the spectrum.
I asked Wheeler in the news conference about the low wage inflation. He pointed to the increase in labour supply in recent years from net migration and increased workforce participation, along with low productivity growth.
He also pointed to the so-called 'composition effects' on wages of stronger growth in the number of services sector jobs, which tended to be low paying. He said the services sector was increasingly being considered a tradable sector "so that's also affecting wage outcomes, particularly the effects of globalisation."
4. Where's the NAIRU?
I also asked Wheeler about the Reserve Bank's view of of full employment, which is also often expressed as the NAIRU - the Non Inflationary Rate of Unemployment.
Some have questioned whether the Reserve Bank should publish its estimate, given Treasury has estimated it was around 4.25 percent - below the current unemployment rate of 4.9 percent and suggestive of spare capacity that was keeping downward pressure on wages and inflation.
Wheeler said the Reserve Bank's research showed full employment could be around 4.5 percent. Assistant Governor John McDermott said the Reserve Bank focused more on wider measures of productive capacity across the economy, rather than just the labour market.
He said the economy was close to full capacity, which the Reserve Bank estimates as the output gap. A negative gap implies spare capacity, while a positive gap implies the economy is 'running hot' and generating extra inflation. The MPS forecast the output gap rising from minus 0.1 percent of potential output at the moment to a high of 1.3 percent in late 2018.
McDermott said it was very difficult to estimate New Zealand's NAIRU because of its past history of relatively high unemployment through the 1980s and 1990s.
"When you try to estimate a typical level of unemployment that's non-inflationary, you can't identify it in New Zealand. It's almost impossible," he said, adding that any attempt in New Zealand was "basically guessing."
Wheeler then commented the Reserve Bank was forecasting the unemployment would fall to around 4.5 percent while inflation rose to around 2 percent.
I asked then if monetary policy should be easier to reduce unemployment towards the NAIRU and soak up spare capacity. McDermott said unemployment was a lagging indicator "so if you wait to find out on unemployment then you're almost too late on monetary policy."
5. DTI consultation nearer
The Reserve Bank's attempts to include a Debt to Income (DTI) multiple limit cap in its Macro-Prudential tool kit were also talked about at the news conference, but not at the select committee.
Finance Minister Steven Joyce announced in February he wanted the Reserve Bank to do a full cost benefit analysis of a DTI before it could be included in the kit, and that the bank indicated then that public consultation would start in March.
Wheeler said he expected a public consultation document would be issued within two to four weeks, and that after that there would be a further round of consultation directly with the banks.
Asked if this meant the potential introduction of a tool was not possible before next year, Deputy Governor Grant Spencer (who will be the acting Governor from September) said it would be some way off and the Reserve Bank would not put an exact timeframe on any introduction.
Wheeler repeated his comments about not needing to use the DTI at the moment, even if he had it, because of the recent moderation of house prices.
6. 'Deal with negative gearing'
I also asked Wheeler about the IMF's comments about the need for the Government to reduce the tax incentives for housing investment.
He said the Reserve Bank had previously talked about the role of negative gearing in inflating house prices.
Asked specifically whether the Government should restrict negative gearing, he said: "They're the sorts of things that any Government that's in office would want to take a look at. What are the sorts of regulatory distortions that lead to house price inflation," he said.
7. Higher rates help affordability?
Elsewhere at the point where politics meet the economy, Joyce made an interesting argument for poor housing affordability: high interest rates.
Joyce said on the eve of the Reserve Bank's decision that record low interest rates all over the world were a major factor in bidding up house prices beyond the reach of many home buyers.
He said a rise in inflation from ultra-low levels would help solve the problem of housing unaffordability, along with measures such as KiwiSaver HomeStart and extra housing supply.
"The biggest problem we've got with first home buyers able to buy properties is we have very, very low interest rates historically, and as a result that's directly linked to how much house prices have been bid up around the world," Joyce told RNZ before the Reserve Bank's announcement of its latest decision.
Joyce agreed low interest rates were not the only reason for problems with high house prices creating housing unaffordability, which were detailed on Wednesday with the release by MBIE of its new Housing Affordability Measures.
"It's not just houses. It's shares and everything else, but it's certainly one of the dominant reasons for that. Unfortunately, it's going to be a little bit of time yet before that changes, although there's indications that this period of ultra-low interest rates is coming to an end. That will improve affordability over time," he said.
"There's no point gilding the lily. One of bigger problems is low interest rates and that's making it difficult for people."
Shortly after those comments the Reserve Bank reinforced that outlook for low interest rates for much longer.
8. Are banks helping?
However, the Reserve Bank and the Government are getting some help from banks that are tightening their lending criteria and nudging up their mortgage rates anyway, regardless of the flat OCR.
That's because banks are experiencing slower growth in retail term deposits from households, which makes it harder and more expensive to fund new lending. Reserve Bank rules introduced in 2010 to reduce the reliance of banks on 'hot' wholesale markets have made the banks more reliant on long term bond issues in overseas wholesale markets, and on local term deposits.
Wheeler said the Reserve Bank's own 40 percent deposit requirement on loans to landlords had slowed overall lending growth, along with the slight rise in mortgage rates and because banks were taking a more cautious approach to keep within their own limits.
He said some of the banks were hitting their own internal Treasury limits for how much funding they could obtain on overseas wholesale bond markets.