RBNZ: 'We're aiming to get inflation back into its box, while engineering a soft landing'

Reserve Bank of New Zealand chief economist Paul Conway. Photo / Mark Mitchell

Reserve Bank of New Zealand (RBNZ) chief economist Paul Conway says the central bank's aggressive official cash rate (OCR) outlook is its "best estimate" for how monetary policy will be set in the coming months and years.

The RBNZ surprised observers last week when it signalled its intention to hike the OCR by more, and sooner, than forecast in April.

It saw the OCR rising from 2 per cent to a high of nearly 4 per cent by June next year.

Speaking to the Herald, Conway expressed confidence in the economy being able to handle the OCR going north so quickly.

"We're aiming to get inflation back into its box, while engineering a soft landing," he said.

"Unemployment is extremely low; household balance sheets are in good shape; people saved money over lockdown. So, there are still buffers there in terms of the balance sheet."

However, Conway provided a reminder the RBNZ's OCR forecast is subject to change.

"There are tonnes of risks around at the moment," he said.

"There is heaps of uncertainty around any economic projection...

"It's monetary policy; it's a repeat game. We'll be back in six weeks' time. We'll revise our forecasts accordingly. It's entirely possible, feasible, that the OCR doesn't have to go as high as we forecast if China, or if the global economy, deteriorates.

"Or likewise, if people embed inflation into their expectations and wage hikes get a bit ahead of productivity, or if prices rise too quickly, then it may have to go higher than what we've forecast," he said.

"It [the OCR outlook] is our best estimate currently and it will move around, it will change, going forward."

Asked about the extent to which the RBNZ's ability to curb inflation was limited, due to the fact around half of the pressures are coming from offshore factors, including supply chain hold-ups due to Covid-19 and higher oil prices due to the war in Ukraine, Conway noted the importance of inflation expectations.

If oil prices rise 10 per cent, for example, will a petrol retailer increase prices by 15 per cent, just in case oil prices rise more?

Conway said the RBNZ was trying to lean against this sort of dynamic, where inflation feeds off itself.

He acknowledged rising interest rates would cause job losses, but expected unemployment to increase "gently".

"We're not forecasting a significant contraction or anything like that."

Conway said the RBNZ was aware of how people's responses to an aggressive tightening of monetary policy might not always be entirely rational.

"For a while there we [economists] sort of thought we were physicists and it was all sort of just mathematics and equations. But it's actually about human behaviour," Conway said.

"Picking these behavioural shifts and how people are going to respond to these changes are absolutely fundamental in pulling off a soft landing."

Asked to respond to criticisms the RBNZ loosened monetary policy too much in response to Covid-19 and/or took too long to tighten policy to prevent inflation reaching the high levels it has, Conway stood by the bank's actions, even though he's only just joined the organisation.

Conway said he would've advocated for the RBNZ taking similar actions to those it did.

He said it's better to have a strong labour market and strong demand than double-digit unemployment – a scenario that was probable when Covid-19 came along.