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Govt Will Instruct RBNZ To Soften Policy Approach

Data Flash (New Zealand)
Government Will Instruct RBNZ To Soften Policy Approach

The RBNZ is expected to shift away from using 1.5% as medium-term inflation target (mid-point of 0-3% target range).

In practice, that may mean a somewhat higher average inflation rate over the cycle.

However, any upward pressure on nominal yields would most likely be offset by a reduction in real yields and the NZ risk premium.

Following a series of critical comments about the RBNZ's approach to monetary policy, Finance Minister Cullen today confirmed his position at the Labour Party's launch of its economic policy platform for the forthcoming election. Current polling suggests that Labour will continue to be the Government after 27 July.

Dr Cullen had been critical of the RBNZ's implicit elevation of the 1.5% mid-point of the 0-3% inflation target range to a medium-term policy target. His comments suggested that he views a 1.5% target - which compares to 2-3% targets pursued by the Fed, the RBA and the Bank of England - as too low. In Dr Cullen's view, the RBNZ's narrow interpretation of the 0-3% target range has led to an overly aggressive policy approach over time, with the current tightening cycle seen as the latest example.

Dr Cullen stated that he wants the RBNZ to look more to the Australian central bank model for the conduct of policy.

However, rather than declaring the intention of altering the inflation target range after the election, Dr Cullen announced today that he will merely alter the wording of the Policy Targets Agreement (PTA). The PTA is an agreement between the Minister of Finance and the RBNZ Governor that specifies the general approach that is to be taken to the operation of monetary policy. Dr Cullen will use the appointment of the new RBNZ Governor (most likely in September) as the opportunity to implement the changes announced today.

We expect the suggested PTA wording change to instruct the RBNZ to use the full width of the 0-3% range to achieve `.flexible management of monetary policy'. In practice, that would mean aiming for inflation outcomes above the 1.5% mid-point, which suggests that New Zealand's average inflation rate will be marginally higher in future.

While that may put upward pressure on nominal yields, an offset is likely to be provided through lower real yields and risk premiums as New Zealand converges towards a less aggressive policy approach that is closer to the international norm.

While we agree with Dr Cullen's intention to soften New Zealand's hard-line approach to monetary policy and align it closer to international practice, we would have preferred the `clean' approach of explicitly changing the inflation target range to, for example, the Australian definition of 2-3%. We view today's announcement, which implies leaving the 0-3% range intact but basically instructing the RBNZ to ignore the bottom half of that range, as a second-best solution.

Ulf Schoefisch, Chief Economist, New Zealand

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