Brian Fallow: Don't reach for the knife, RBNZ

Reserve Bank of NZ Governor Adrian Orr. Photo / File

COMMENT:

The Reserve Bank should leave the official cash rate on hold at 1 per cent next week.

Neither part of its dual mandate — price stability and maximum sustainable employment — presents a compelling case for adding to the 75 basis points of easing it has already dispensed over the past six months.

The starting point for consumer price inflation is 1.5 per cent in the year to September. That is within the target band of 1 to 3 per cent and importantly, the non-tradables share of the CPI — which is what the Reserve Bank can influence — at 3.2 per cent is the strongest it has been for eight years (when it was still boosted by a rise in the GST rate).

September was too soon for much of the first third of those 75 basis points of easing to flow through the tortuous channels — silted up as some may be — to consumer prices.

As for tradables prices, whose persistent collective decline reflects powerful disinflationary forces in the global economy, some boost should lie ahead from the decline in the exchange rate, by 1.6 per cent over the past six months on a trade-weighted basis.

The Reserve Bank's own preferred measure of core inflation remained steady at 1.7 per cent, where it has sat for more than a year now.

Market economists who call for a further cut in the OCR point to indicators that the economy is slowing and argue that will make it harder to push inflation up to 2 per cent.

But the bank's inflation remit is not a point target of 2 per cent. It is to "keep future annual inflation between 1 and 3 per cent over the medium term, with a focus on keeping future inflation near the 2 per cent mid-point."

"Near" is an elastic term and aiming for the bullseye maximises the chances of landing somewhere within the target's 2 percentage point diameter. The language about a focus on 2 per cent was added after several years when inflation had been wobbling around the 3 per cent top of the target band. Those days are long gone.

So if the Reserve Bank really does believe, as it insists it does, that cuts to its policy rate are just as effective when rates are as low as they now are, then it should expect inflation to rise from its current, already respectable level.

It is not as if there is no downside to further cuts.

One of the main ways a lower OCR boosts demand in the economy is to increase the sum home-buyers feel able to borrow, pushing up house prices and household debt. Both are already very high relative to incomes, discouragingly so for aspiring first-home buyers.

But higher house prices make existing owners wealthier and willing to spend a few cents in the dollar of their paper gains in housing equity.

We have a chronically negative household saving rate: households collectively spend more than their income. The Reserve Bank expects that to continue and seems to be relying on the wealth effect to stimulate spending and generate consumer price inflation as well.

Rising house prices would be one likely result if the official cash rate went even lower. Photo / File

House price inflation is also underpinned by a very high prime-age employment rate. The proportion of New Zealanders aged between 15 and 64 who are employed is 77.4 per cent. It is bettered by only four of the OECD's 36 member countries and is 6 percentage points higher than in the United States, which is supposedly enjoying the strongest labour market for a generation.

That high employment rate will fall at some point. It is only a matter of time before the economy is once again sideswiped by some negative international shock, hopefully less severe than the global financial crisis 11 years ago.

Every OCR cut at this stage in the cycle is not only liable to push up household debt levels, but also leaves the Reserve Bank with less scope to provide interest rate relief if, or rather when, a lot of two-income households become one-income households.

Meanwhile, with respect to the other leg of the Reserve Bank's mandate — to support maximum sustainable employment — Wednesday's labour market numbers were cheerful enough.

True, the unemployment rate snapped back from the June quarter's drop to an 11-year low of 3.9 per cent.

But at 4.2 per cent, it is within the Reserve Bank's estimated range for "Nairu", the unemployment rate below which inflation is liable to take off.

And the unemployment rate is a ratio whose denominator, the labour force, is still boosted by a participation rate which is holding up above 70 per cent of the working age population, which is historically high.

The broadest measure of labour market slack, the underutilisation rate, improved to 10.4 per cent, an 11-year low, or just under 300,000 people. That includes not only the officially unemployed but the under-employed (part-timers able and willing to work more hours) and those jobless people who say they would take a job if one was available but who are not actively seeking one (which you have to be doing to count as officially unemployed).

Employment growth continued to slow, to an annual pace of 0.9 per cent, on a headcount basis. But the proportion working full-time rose, pushing hours worked up 2.1 per cent on a year ago.

The labour market is tight enough to be delivering some decent wage growth. Average hourly earnings (ordinary time in the private sector) rose 3.9 per cent in the year to September or 2.4 per cent in real terms.

The proportion of pay rates which rose in the latest year, 59 per cent, is the highest since March 2015 and just over half of the increases were 3 per cent or higher, the largest proportion since June 2012.

That suggest that reports of the death of the Phillips curve are premature.

And given that the judgment of the Reserve Bank's monetary policy committee six weeks ago was that employment was around the targeted maximum sustainable level, there is no reason for it to depart from that view now.