Sludge Report #134 - Dr Don Spots A Dark Cloud
In This Edition: Dr Don Spots A Dark Cloud Behind The Silver Lining
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Dr Don Spots A Dark Cloud Behind The Silver Lining
On a morning that when the Federal Open Market Committee has decided unanimously to maintain near record low interest rates at 1.75%, the New Zealand Reserve Bank has decided to raise rates by 0.25% to 5%.
Cynical observers may note that as the Federal Reserve led the way down last year, NZ Reserve Bank Governor Dr Don Brash was consistently behind the play, and that now the post 911 blues are starting to dissipate, Dr Don today lead the world with his decision to take rates back up again.
They might also note that whereas in the US the 40-year-low in the Federal Funds Rate is described as “accommodating”, here in NZ (the land of high interest rates) our 5% Official Cash Rate is described as “stimulatory”.
Meanwhile the explanation for why Dr Don believes a rate rise is necessary today , at least in this observer’s view, falls far short of satisfactory.
Essentially the answer is that Dr Don and the RBNZ gnomes believe Inflationary pressures are not abating.
Note they do not say they are increasing, but just that they might increase if he doesn’t do something to stop them.
To wit, Dr Don says:
“... if things evolve as now seems likely, there will be a need for higher interest rates if inflationary pressures are to be contained...
...indications are that pressures will grow further in the absence of some increase in interest rates...
...the risk is that this prolonged period of inflation near the top of the inflation target may lead people to adjust their inflation expectations upwards, making the task of controlling future inflation more difficult...”
So in other words, it’s our fault. Thought so. Albeit not for anything we have actually done, but just for something we might do but for Dr Don’s gentle persuasion to the contrary.
In the circumstances it pays to look at Dr Don’s analysis of inflation more closely to find out what’s really up in the back rooms at No. 2 The Terrace.
As students of NZ monetary policy will be well aware, according to his empowering legislation the only ball that Dr Don has to watch is the inflation rate, and then - thanks to generally accepted wisdom - he only has to watch this in a crystal ball. This is because some economic theory indicates anything the RBNZ does now will only affect our behaviour 18 months out.
I suspect the good Dr might find it illustrative to test this theory by interviewing some Naenae housewives.
He might for example, since he appears to be so concerned about the price of vegetables, ask them whether an extra $30 a month on the mortgage today will have any impact on the quantity of vegetables they purchase in November 2003?
To be fair, Dr Don points out in his analysis that vegetable and fruit prices are largely up due the weather, and he also observes that another component of inflation, petrol prices, is largely out of his control.
He then provides 15 separate tables of inflation measures – a moving target is always harder to hit - before concluding, “...there is no conclusive evidence that the persistent elements of inflation are accelerating but nor are there any signs they are falling away...”
Another gem in the bank’s analysis is the glib conclusion that the introduction of income related rents by the Government last year “distorted” in the inflation rate by lowering it 0.6%.
Consequently the fact that the December CPI outcome of 1.8% was remarkably close to the target level of 1.5% is a piece of encouraging news that we should not put too much store in. Note there is no discussion here on whether the “distortion” created by removing artificially subsidised market rentals (subsidised via the accommodation supplement - which is presumably not a distortion but rather a market mechanism) in state housing will have any secondary impacts on lowering rental inflation generally throughout the market.
The report then dismisses the fact that the December Quarter showed non-tradable inflation (the bit the Reserve Bank has an influence on ) at just 0.9 % well inside comfort zones saying, “this annual percentage change is considerably lower than the rate seen through late 1999 and 2000 but was pushed down by the rental policy change. The annual tradeables ex-petrol series and non-tradeables ex rents series are both considerably higher.”
One can only presume therefore that now petrol prices are back on the way up again that the Reserve Bank will ignore the impact this has on the inflationary outlook to.
Also starring in the inflation analysis of the RB’s gnomes is the impact of immigration.
On the negative side (inflation wise) this is likely to increase pressure in an already increasingly bouyant property market. On the positive side however the influx of skilled migrants is relieving tightness in the Labour market, reducing the pressure for wage inflation.
Readers will find it far from surprising to learn that Dr Don prefers the former of these arguments to the latter.
On the question of whether the Labour market is loosening his report notes:
“...the cause of the decline [in job ads] is not entirely clear. Recent inflows may be making jobs easier to fill. While fewer job ads might signify weaker labour demand, this was not borne out by the sharp rise in employment in the December Q. A rebound in job ads in February might suggest that the reduction in labour market pressure was temporary...”
“..Many of our business contacts continue to note substantial difficulties in locating the right kinds of staff, particularly in some rural regions of the country.”
So in other words, in this instance at least the Reserve Bank prefers to follow its nose than the numbers. Economically speaking it is worth noting that the Reserve Bank has no beef with more people finding jobs, just with them asking to be paid more.
The bottom line of all of this analysis – which might be reasonably compared to the proverbial debate on the number of angels on the head of a pin - is that the Reserve Bank this morning had to make a line call.
Judging future inflationary pressures is inherently an exercise in crystal ball gazing, and at the moment the data is inconclusive either way.
However when working with Dr Don there is one thing we can always count on, his well proven ability to spot the dark cloud behind every silver lining.
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