Brian Fallow: Reserve Bank got OCR drop wrong

Reserve Bank Governor Adrian Orr. Photo / File

COMMENT:

The Reserve Bank's new monetary policy committee has chosen to mark its debut by jumping the gun.

The case for an official cash rate cut at this point is not as strong as the bank — and to be fair, many of the denizens of dealing rooms — evidently thought.

The case it makes is all about projections of a continuing trend of weakening growth which it believes is already under way.

But is it though? And if it is, to what degree is that evidence of slowing demand, which a lower interest rate might help, and how much is to do with capacity constraints on the supply side, which monetary policy can do nothing about?

Take the labour market, the state of which is central to both legs of the bank's dual mandate: price stability and maximum sustainable employment.

The narrative that seems to have emerged about last week's labour market numbers goes like this: Oh dear, employment growth, which has been slowing for a couple of years, has now stalled, while wages are stagnating. Whatever happened to the Phillips curve?

But in fact, the decline in (seasonally adjusted) employment between the December 2018 and March 2019 quarters falls well within the margin of sampling error for the survey — so it might be real, it might not — and is concentrated among part-timers.

The slowing trend of jobs growth could be evidence of employers' difficulty accessing the skills they are looking for, rather than weakening demand that might benefit from an interest rate cut.

In any case, the weak labour market story is challenged by the hard data coming from Inland Revenue.

Source deductions, the vast majority of which is PAYE, over the 12 months to March are up 7.4 per cent on the year before. On the same annual average basis, the number of people employed is up 2.2 per cent, leaving a per capita increase in the PAYE take of more than 5 per cent.

That takes a lot of explaining away if you don't think anything much has been happening to wages — a view that reflects a baffling focus on the heavily adjusted labour cost index (2 per cent) rather than the quarterly employment survey which found a more cheerful 3.7 per cent rise over the past year.

Prima facie, the tax out-turn data suggest either more jobs growth, or more wage growth, or both, than the survey-based data indicate. That could mean more pressure on profit margins and ultimately prices, but also more household income.

The bank's forecasters do not include the PAYE data in the suite of labour market indicators they look at. But it is an area of research, we are told.

Meanwhile on the inflation front, CPI inflation at 1.5 per cent is comfortably within the 1 to 3 per cent target band, while non-tradeables inflation (the kind the Reserve Bank can influence) has been rising for three years and is at a five-year high of 2.8 per cent, and its preferred measure of core inflation is steady at 1.7 per cent — closer to the bullseye than the edge of the target.

Latest data suggests the job market is weakening, but the tax take tells the opposite story. Photo / File

At Wednesday's press conference, governor Adrian Orr pointed out that subdued inflation, even this long into an expansion and with policy interest rates generally at historic lows, was a global phenomenon.

He suggested it reflected a positive productivity shock from technology, the emergence of a single global labour market through an open trading system and the success of central banks in bedding in expectations of low inflation.

But the Bank of New Zealand's head of research, Stephen Toplis, says that provided low inflation is not indicative of weak economic conditions but reflects structural change, central banks should not be concerned by this development.

"There is a very real risk in the current approach that when economies inevitably turn down, monetary authorities will have exhausted the ability of interest rates to provide the impetus that might, at that stage, be so desperately needed," Toplis said.

The monetary policy statement says that at the same time as domestic growth momentum has continued to slow, the support to demand in New Zealand from the global economy has faded.

But export prices have been rising overall since the start of the year while the exchange rate, on a trade-weighted basis, has gone sideways.

The basket of commodities in ANZ's commodity price index is up 8.4 per cent on a year ago in New Zealand dollar terms, boosting rural incomes, you would think.

Finally, there is the question of how much good a 25 basis point cut in the official cash rate would do at this stage.

The bank says it is necessary to keep employment near its maximum sustainable level and to keep inflation near the mid-point of its target.

But Toplis argues that the effect of a cut to the OCR varies, depending on when in the cycle it is made.

And right now the main channels through which a rate cut would flow through to the real economy are clogged up by one thing or another.

When households are as heavily indebted as they are after several years of runaway house price inflation, might they not use a rate cut to reduce debt rather than spend it?

At a different stage in the cycle, rate cuts might spur investment in house construction; right now, with builders flat out, more demand is the last thing they need.

And while there is a need for more business investment, when productivity growth has slowed to a crawl, is it really the cost of credit that is holding that back, rather than uncertainty over government policy or compressed profit margins?

The central bank's forecasts have the output gap — the difference between actual and potential growth rates — at zero for the coming year. One might think that is a sweet spot.

It judges employment to be near its maximum sustainable level and to soften "slightly" over 2019. But "over the medium term the unemployment rate declines to around 4 per cent [from 4.2 per cent now] and the output gap rises slightly above zero." Hear the danger klaxon blaring? Me neither.