Monetary tightening brought forward @New Zealand

The Monetary Policy Committee today increased the Official Cash Rate (OCR) to 1.50 percent. The Committee agreed it is appropriate to continue to tighten monetary conditions at pace to best maintain price stability and support maximum sustainable employment.

The Committee remained comfortable with the outlook for the OCR as outlined in their February Monetary Policy Statement. They agreed that moving the OCR to a more neutral stance sooner will reduce the risks of rising inflation expectations. A larger move now also provides more policy flexibility ahead in light of the highly uncertain global economic environment.

The level of global economic activity continues to generate rising inflation pressures, exacerbated by ongoing supply disruptions in large part driven by COVID-19. The Russian invasion of Ukraine has significantly added to these supply disruptions, causing prices to spike in internationally traded commodities and energy.

However, the pace of global economic activity continues to slow. There is an elevated level of uncertainty created by the persistent impacts of COVID-19, and clear signals that monetary and broader financial conditions will tighten over the course of 2022. Added to this is the high level of geopolitical tension and related economic sanctions on Russia.

In New Zealand, underlying strength remains in the economy, supported by sound balance sheets, continued fiscal support, and strong export earnings. There has been some economic disruption due to the outbreak of Omicron. However, the high vaccination rates across New Zealand are assisting to reduce this disruption.

Heightened global economic uncertainty and inflation are dampening consumer confidence. The rise in mortgage interest rates – amongst other factors – have acted to reduce mortgage demand and house prices. However, economic capacity pressures remain, with a broad range of indicators highlighting domestic capacity constraints and ongoing inflation pressures. Employment is above its maximum sustainable level and labour shortages are impacting many businesses.

The Reserve Banks core inflation measures are at or above 3 percent. Inflationary pressure is being further accentuated by current high imported energy and commodity prices, which are lifting headline CPI inflation. The Committee will remain focused on ensuring that current high consumer price inflation does not become embedded into longer-term inflation expectations.

Summary Record of Meeting

The Monetary Policy Committee discussed developments affecting the outlook for monetary policy.

It was noted that global consumer price inflation is high, well above most central banks targets. This general inflation pressure is due to the recent recovery in global demand running up against severe supply shortages and trade disruption. The economic disruption caused by COVID-19 has been exacerbated by rising energy and food prices resulting from the Russian invasion of Ukraine.

The Committee noted that global economic growth is slowing, given supply constraints, consumer price pressures cutting into real incomes, and heightened geopolitical tensions causing investment uncertainty. Central banks globally are also tightening, or looking to tighten, their monetary policy stances over 2022, in an effort to constrain consumer price inflation expectations consistent with their policy targets.

Members observed that financial conditions have tightened in New Zealand, with higher interest rates, a stronger New Zealand dollar exchange rate, and lower asset prices.

It was noted that mortgage interest rates have risen broadly consistent with the outlook for the Official Cash Rate (OCR) in the Reserve Banks February Monetary Policy Statement. The Committee noted that the higher New Zealand dollar against trading-partner currencies has assisted to partly offset higher import prices for local consumers.

In discussing the underlying influences on higher domestic inflation, the Committee agreed that both international and domestic factors were important.

Headline inflation is rising largely as a result of disrupted supply chains and higher world commodity prices. These higher commodity prices are increasing both imported inflation and also the incomes of some New Zealand exporters. Domestic demand pressures, relative to supply capacity, are also pushing New Zealand‘s core inflation above the Bank’s 1 to 3 percent target range.

Capacity pressures are apparent across a wide range of domestic indicators. In particular labour shortages remain heightened, impinging on domestic economic output. Nominal wages are rising in response to these shortages, as would be expected. However, the increasing cost of living is putting pressure on household budgets. Consumer confidence has been declining as domestic price pressures are outpacing nominal household income growth.

The Committee discussed the outlook for labour supply with the reopening of New Zealands international border underway. Members agreed that while the medium-term outlook is for ongoing net inward migration, as is the historical norm, this level would take some time to rebuild. Near-term indicators highlight that New Zealanders are currently leaving in larger numbers than visitors are arriving, as the border is opened in stages. The Committee noted that net immigration is assumed to increase only slowly, eventually leading to a gradual easing in skill shortages.

House prices have fallen from their recent high levels. The Committee viewed this as a sign that house prices are moving towards a more sustainable level. Home building intentions remain at record levels, which will assist this adjustment. However, construction activity faces challenges, including access to land, rising building costs, ongoing supply chain bottlenecks, and limited access to labour. The construction sector is operating around peak capacity.

Members noted that inflation is above target and employment is above its maximum sustainable level. As such, the Committee confirmed that further increases in the OCR are needed in order to meet their mandate.

The Committee discussed the pace and extent to which the OCR needs to rise in order to meet their inflation and employment mandate.

Members noted that annual consumer price inflation is expected to peak around 7 percent in the first half of 2022. The risk of more persistent high inflation expectations has increased. The Committee agreed that their policy ‘path of least regret’ is to increase the OCR by more now, rather than later, to head off rising inflation expectations and minimise any unnecessary volatility in output, interest rates, and the exchange rate in the future. The Committee agreed to a 50 basis point rise in the OCR, consistent with this least regrets analysis.

The Committee noted that the OCR is stimulatory at its current level. Members agreed that a larger rise in the OCR now is consistent with the forward path for interest rates outlined in their February Statement. Members also agreed that this ‘stitch in time’ approach is consistent with near-term financial market pricing.

On Wednesday 13 April, the Committee reached a consensus to increase the OCR to 1.50 percent.