Hello and welcome to the Of Interest podcast. I'm Gareth Vaughan from interest.co.nz. Last Wednesday, November 29th, the Reserve Bank reviewed its monetary policy settings for the final time in 2023. The official cash rate, or OCR, was left at 5.5%, where it has been since May. It was widely regarded as a hawkish review, however, with the OCR forecast to reach 5.7% next year and the Reserve Bank moving to dampen financial markets' expectations of a rate cut in 2024. Joining me to discuss this and more is Reserve Bank Governor Adrian Orr. Hi Adrian, and welcome to the Of Interest podcast. It's great to have you with us.
Wonderful to be here, Gareth. Look, I thought we'd kick off by chatting a bit about the market reaction to that monetary policy statement. We're sitting here on the following Monday morning, so a few days down the line. I was looking this morning at a note from Westpac, who were saying New Zealand rates markets are pricing the OCR currently at 5.5% to be unchanged on February 28th, which of course is your next review, with no further rate hikes in this cycle and an 80% chance of a rate cut in August 2024. So I'm just wondering, you know, are the markets listening to your warnings that there are upside risks to inflation and that this needs to be taken seriously?
I think the markets are. I mean, they know exactly our purpose, our mandate. They know the starting point for where we are, you know, the asymmetric risks to the inflation outlook at the moment. And, you know, we just need to repeat we're willing to do whatever it takes to achieve our mandate, our low and stable inflation. Our market pricing, of course, is driven by many things other than just us holding an overnight cash rate. So, you know, the pricing that you're looking at reflects the global markets, international outlook for economic activity and inflation. And I know the US Federal Reserve is having similar challenges, as the RBA, the Bank of Canada around the world, to say, 'Hey, it's too early to start talking about cuts.' In fact, if we get further inflation shocks, there may be more work to do. So we're in a holding position, but we've made it clear where our nerves sit.
And obviously February 28th is your next review, so that's three months away. So it's a good long break between meetings, and we're heading now into the Christmas and summer holiday season here in New Zealand. So I'm sure, aside from enjoying the festivities and a bit of a holiday yourself and your monetary policy committee members, colleagues will be keeping an eye on things. So I'm really interested in what are the key events or data or other developments that you're going to be watching between now and February 28th.
Yes, I mean, without doubt, you know, we have the official dates that we can act, but I reminded the audience that the bank has a history of saying what it needs to say when it needs to say it. So if there were unanticipated surprises during that period, we would be back with the market. We don't forecast that at the moment. In terms of what we're looking for, there's a wealth of data domestically and internationally. We've got that lagged actual inflation number. We've got the continued business confidence and inflation expectations surveys that we are particularly interested in. And we've got GDP and employment growth numbers. So really good solid data points between now and when we next produce a monetary policy statement. All of those, we are very transparent. We've got projections for all of those variables, and we're going to need to see how the outturns stack up to where we think we are at the moment. And we're going to have to look for continued subdued economic growth, continued supply capacity being freed up, whether that's in the labor market and globally across the supply chains, and really affirming around that inflation expectations to where we need to see them. So some critical data at an important time. We know that inflation expectations are following very closely actual inflation, so to get another CPI number will be useful for us.
Yeah, absolutely. In terms of, I guess, what you would need to see for you to be a bit more relaxed about the inflation outlook, what would you need to see change?
I think we need to see a lot of the numbers that we are projecting actually land. So we would need to see that subdued growth. A good insight as well, we'd need to see what's happening to net migration. We've had incredibly strong inward migration over the first half of the calendar year. The way it's measured now is not straightforward; there's an algorithm updating us kind of real time, and it's showing it starting to tail off. We need to see it tailing off to understand the implications for demand pressure. So basically, we need to see more spare capacity in the economy to have real confidence that the inflation pressures are coming off. All the indicators are moving in the right direction, but there's a lot of news still to arrive on the table.
I think in the monetary policy statement itself, I did a word count on the word 'immigration', and I think there were 40-odd, maybe 43 mentions in the 58 or so pages. Immigration really has boomed this year. Clearly that is something you are watching closely in a monetary policy context, and obviously housing is a key factor there, because people who move to New Zealand need somewhere to live, whether it's a rental or buying a home. So how significant a threat to inflation is that sharp rise in inward migration?
Yes, I think, and well spotted, it is a big topic. It's historically significant, the amount of net inward migration, the population growth that we've got. And it's even internationally significant. You're seeing countries such as Australia, Canada, and ourselves, those countries with strong net inward migration having the highest core inflation challenges, in particular through the dwellings, the rental prices, and the pressure on aggregate demand. So it is an important topic for us. It's not straightforward. The very first part is inward migration has significantly supported our labor market. We were so short of workers that was leading to wage inflation pressures, but more importantly, bottlenecks right across all activity. The context with this migration boom that we're having has been very useful; it has loosened up that labor supply, and we're seeing wage growth having peaked, and the potential capacity of the economy growing. But now, over recent months, the impact on the demand side rather than the supply side of the economy is becoming more and more evident. We're seeing per capita spending decline, so we are doing it tough in New Zealand, but we're seeing total spending rising because there are more people spending, more people in the economy. So we've seen aggregate demand hold up much stronger, explaining a stronger than expected GDP profile. And we're also seeing rental dwellings holding up. So these are really important parts of the homegrown inflation story. So it's going to be that balance between supply and demand. While supply was winning, demand is coming back into the second round.
Yeah, absolutely. Now look, obviously since March 2018 when you became governor of the Reserve Bank, you've had two targets in your monetary policy remit: inflation, of course, Consumer Price Index inflation between 1 and 3% over the medium term with a focus on the 2% midpoint, and you've also been tasked with supporting maximum sustainable employment. Now, we've got a new government and they want to remove the maximum sustainable employment remit. I'm just wondering, how different would Reserve Bank monetary policy settings have been over the period since you've been governor if that maximum sustainable employment mandate hadn't been there?
Yeah, it's a great question. Under both constructs, inflation is the primary target. We aimed at maintaining low and stable inflation whilst contributing to maximum sustainable employment. So there is a hierarchy there, but obviously it's created communication challenges. This government is saying, let's clear it up and just go back to the one inflation. How different would it have been on the decisions? I can confidently say no different to what we've been doing over the last X years that you mentioned. Why can I say that confidently? It's just that we haven't had a trade-off between inflation and employment or unemployment over that period. That just happens to be the economic context we're in. In all cases, both inflation and employment were on the same side of the equation. So tightening or loosening policy, there was no trade-off involved. That's not to say that couldn't happen in the future. You could be in positions where inflation's very high but unemployment may be rising as well, and you have to bite the bullet and trade one off versus the other, which would be aiming for that low inflation. So over the last few years, no, the challenges to us haven't been our mandate; they've been everything else. There've been a few.
Look, obviously the Consumer Price Index, which you track very closely, it went through the RBNZ target range in June 2021, rising to 3.3%, peaked at 7.3% in June of 2022 from memory, and in the last September quarter this year was down to 5.6%. So it seems to have peaked and be trending down. I'm quite interested in how you attribute your OCR increases to that fall and how you measure that. And I'm quite interested in the context that Joseph Stiglitz, the Nobel laureate economist and Columbia University professor, recently wrote an article. He was talking about the US, but I think it's still of relevance to us. He was saying that raising interest rates didn't address the problem we faced, which was supply side and demand shift inflation. If anything, disinflation has happened despite central banks' actions, not because of them. I'm just wondering, in a New Zealand context, what do you make of those comments and how much do you think the rate hikes have actually driven inflation lower?
Yes, well, I think the underlying part of what Stiglitz is saying there is have some humility around what monetary policy can or can't achieve, and I certainly buy into that humility. Over a long period of time, headline inflation has been held down lower than otherwise because of global prices declining, in large part what I would call the China inflation dividend. Three decades now of falling prices for real goods coming out of this engine of economic production being China is now largely running its course. So central bankers can't just rely on higher than otherwise domestic inflation saved by lower than otherwise imported inflation. So that is a focus for us. Even though headline inflation has come off, we remain concerned around the homegrown domestic core part of inflation because we can't just rely on the hope that commodity prices or goods prices will always come and save the day. Looking through the impact of monetary policy, I agree with Joseph Stiglitz that supply shocks were an incredibly important part of the inflation story over the last seven to eight years. Unprecedented stop-start bottlenecks, complete global shutdown, so on and so forth, constraining the supply. But I wouldn't go the whole way of saying that demand hasn't played a critical role. Globally, government fiscal policies, wage subsidies, business support schemes, automatic stabilizers, as well as unprecedented low interest rates created demand, created asset prices, created wealth, created spending. So it's a combination of the two that tells the whole story going forward. What have we seen since 2022 when we've been tightening? We've seen incredible restraint come in because of the monetary policy tightening globally. Asset prices have shifted significantly back, particularly house prices. You're seeing spending per person declining. Business investment and credit growth slowing rapidly. So monetary policy really is an important part of why inflation is declining now, assisted by some of those supply bottlenecks and global commodity prices. So it's a combo, but we can only impact the main domestic part.
Yep, absolutely. And I guess looking ahead, there's a school of thought that we're in a more uncertain world now than we were a few years ago. There's the push to net zero with our economies and the changes that's going to bring, the geopolitical tension between the US and China, and various uncertainties. Do you think that we are in a world now where we had very low inflation for a long time leading into the COVID pandemic, and obviously the questions you would have been getting before that were that inflation's too low, it's below your target. It would appear that we're not going back to that world anytime soon. Or do you think we might? What are your longer-term views for the inflation outlook?
I'm extremely confident that the globe is heading back to a period of low and stable inflation, but it may be generated by more monetary policy central bank focus than that China inflation dividend we talked about. If you look at the history of New Zealand's inflation, we've been averaging somewhere around 2%, if not a bit lower, for a long period of time. But that was at a time when what we call our non-tradeable inflation, the domestic home ground component, was at 3% or more, and tradeables inflation was negative. So we were being helped out by those positive trade winds, primarily from China. Looking ahead, it just means that we have to have more focus on the domestic inflation component, not necessarily being able to rely continuously on a whole new labor force being discovered somewhere. But low and stable inflation is still the only and obvious goal. A lot of concern where people get confused is the difference between generalized inflation, where all prices are rising and we're all double guessing each other, versus relative prices shifting. Relative prices need to move; they signify quality, quantities, supply. That's what relative prices do, but it doesn't need to lead to aggregate inflation. So no, I'm still fully convinced the world is heading back to low and stable inflation, but there may be higher interest rates on average to achieve that.
There's been a lot of discussion and debate over the last couple of years about what's being referred to as profit-led inflation, or sellers' inflation, or some call it greedflation. I'm interested to what extent you believe that this has played a role in New Zealand's current bout of high inflation.
