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Dataflash (NZ) Brash Speech Confirms Tough Policy

Data Flash (New Zealand)
Brash Speech Confirms Tough Policy Approach

Key Points

RBNZ Governor Brash gave his annual speech to the Canterbury Employers' Chamber of Commerce.

The focus was on long-term driving forces of growth, including a skilled labour force, the employment of new technologies, the openness of the economy, an innovative and and efficient public sector, etc.

Dr Brash stated that macroeconomic stability was a key ingredient to successful economic performance.

Fiscal responsibility, including running fiscal surpluses to achieve public debt reduction, had been a key feature of successful macroeconomic policy during the past decade in New Zealand.

Dr Brash reiterated that monetary policy could make its strongest contribution by focusing on medium-term price stability.

Policy settings had to be adjusted in response to the inflation outlook one to two years ahead.

He noted that `. what prompts an increase in the OCR is when growth in demand looks like getting out of line with growth in the capacity of the economy ..' - supposedly reflecting on the RBNZ's decision on 19 January.

However, the RBNZ had become more relaxed about short term `wobbles' in the inflation rate, such as those caused by moves in the exchange rate, i.e. the direct price effects of a currency adjustment.

Dr Brash said that that approach recognised the trade-offs that sometimes existed, in the short term, between monetary policy and growth and reflected the provisions of the new Policy Targets Agreement.

He concluded, however, by saying that `In many situations, the best way to minimise fluctuations in inflation, output, interest rates, and the exchange rate will be to adjust the OCR firmly and promptly to guard against emerging imbalances emerging in the economy.'

That statement should be seen as another justification of last week's RBNZ decision, particularly in the light of comments made during the Q&A session following the speech: - While he called the timing of the rate hike `embarrassing', Dr Brash reiterated that historical CPIs have limited relevance for rate rise decisions. Knowledge of the low Q4 CPI would not have stopped the rate hike. - He said that he did not understand why the Q4 CPI was so much lower than forecast (0.2% qoq vs 0.7-0.9%). - Growth was running at 1% per quarter and the RBNZ's view is that excess capacity in the economy will be exhausted shortly - with growth in potential output seen at around 3%. - Commenting on monetary conditions, Dr Brash called the NZD `very low'.

Conclusion

It appears that the RBNZ largely discounts the Q4 inflation result and shows no sign of subscribing to the view that the `new paradigm' has arrived in New Zealand.

The Bank appears increasingly concerned about the combination of continued strong growth and emerging inflation pressures on the one hand, and the underperformance of the NZD on the other.

With Dr Brash confirming his view that a firm policy approach delivers the best medium-term outcomes, a continued low NZD implies increasing upward pressure on short-term interest rates.

While our central forecast for the 15 March OCR review is still a 25 bps increase, the probability attached to a 50 bps move has risen significantly.

Ulf Schoefisch, Chief Economist, New Zealand, (64) 9 351-1375

This, along with an extensive range of other publications, is available on our web site http://research.gm.db.com

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