Shake off any rate cut ideas in NZ

Philip Borkin

Senior Economist, ANZ

Still expecting the next move from the Reserve Bank of New Zealand to be a cut? Well shake off that feeling - at least for now. There was enough in New Zealand’s latest inflation figures, with core measures continuing to push higher, to suggest a lowering of the official stance is not imminent.

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This is confirmed by an update of ANZ’s Taylor Rule estimates. But a lot still hinges on the outlook for growth and risks on that front remain skewed to the downside. Stronger inflation and weaker growth is hardly a favourable mix.

"A lot still hinges on the outlook for growth and risks on that front remain skewed to the downside.”

Stats this week showed the NZ consumer price index lifted 1.5 per cent year on year in the 12 months to June, with housing costs supporting the rise.

The move was in line with RBNZ forecasts (although stronger than ANZ’s) and has seen the market quite rightly pare back expectations for an Overnight Cash Rate (OCR) cut.

Tinker

Jack Johnson reckons Taylor was a good girl and as an economist she’s supporting a no-cut stance at the moment. The Taylor Rule is a widely used technique to explain central bank behaviour through the relationship between short-term interest rates, inflation and economic spare capacity.

It is, as described by former US Federal Reserve chair Ben Bernanke, “a simple equation, essentially, a rule of thumb, that is intended to describe the interest rate decisions of the [Fed]”.

Since the model was proposed by Stanford economist John Taylor in 1993 there have been numerous iterations and suggestions for how the model should be specified for different countries.

That has included using time-varying estimates of the neutral interest rate or including other variables - such as the exchange rate - as well as the standard inflation and output gap variables.

As of June, the range of ANZ’s Taylor Rule estimates varied from 1.7 per cent to 2.4 per cent, which is up from a range of 1.4 per cent to 2.2 per cent in March.

ANZ’s Taylor Rule model is not forward looking of course –not any more forward looking than what you can already garner about future inflation from its current level and measures of spare capacity.

These models always need to be viewed with that in mind. If ANZ’s forecasts for headline inflation and the unemployment rate are plugged in, then the models imply the first OCR hike around the middle to latter part of 2019, which is actually similar to ANZ’s current forecast (November 2019).

But what it also implies then is in order for rate cuts to be contemplated more seriously again, something is going to have to change to alter that medium-term picture - and most likely that will be a further deterioration in the domestic growth outlook.

In other words, the weak signal currently provided by business sentiment surveys will actually need to start to permeate the broader economy.

Context

The RBNZ looked at a few different versions of the Taylor Rule specification in a New Zealand context here.

ANZ’s own version of the Taylor Rule is relatively simple in its specification. It estimates the RBNZ’s policy stance (proxied by the level of the OCR) through deviations in inflation from its target midpoint (either using headline CPI inflation or the sectoral factor model), the unemployment gap (the difference between the unemployment rate and our various estimates of the NAIRU) and the spread between the floating mortgage rate and the 90- day bank bill rate.

In many ways, the last is a useful proxy for a time-varying estimate of the neutral interest rate.

ANZ hasn’t haven’t made any changes to its Taylor Rule model to account for the recent shift to the RBNZ’s soft dual mandate, largely because the changes are so fresh and because both inflation and employment are included in our specification in some shape or form already.

However, it would be interesting at some point in the future - perhaps through rolling-regression analysis - to see whether this new mandate does see a shift in the RBNZ’s reaction function relative to how it has behaved in the past.

Phil Borkin is a Senior Macro Strategist at ANZ NZ

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.