Brian Fallow: Expect Reserve Bank to keep things loose

OPINION:

The Reserve Bank can be expected to renew its monetary policy prescription, dosage unchanged, when it reviews it next Wednesday.

Since its February statement the outlook has brightened in some respects, particularly the beginning of vaccination and the confirmation of a transtasman travel bubble, but it has darkened in others.

Last month’s lockdown, limited in duration and location as it was, is a reminder of how fragile New Zealand’s Covid-free status remains in a world where more than 600,000 people a day are diagnosed with the virus and more than 12,000 a day die of it.

“This ongoing uncertainty is expected to constrain business investment and household spending growth,” the monetary policy committee said in February. Surely that is still true.

While vaccination and the travel bubble should prove positive for sentiment, the Government’s moves to deflate the other bubble, the one in the housing market, could prove negative for domestic demand.

Given the association between rising house prices and increases in consumer spending, economists expect the Reserve Bank to see the housing-related tax changes as making it harder to reach its inflation target.

While a housing bubble inflated by a combination of avarice, desperation and cheap credit has provided some buoyancy for the economy, it is no recipe for a sustainable recovery.

The travel bubble’s lifeline for the tourist industry is a more sturdy foundation.

It should not be overestimated, however. Tourism Industry Aotearoa chief executive Chris Roberts said that, while about 40 per cent of international arrivals pre-Covid were from Australia, about a third of them were New Zealanders coming home to see friends and family.

“Excluding air fares and some other pre-travel costs, Australian arrivals spent about $3 billion a year in New Zealand, around 25 per cent of the total international visitor spend.”

In a $300b-pluseconomy a resumption of a decent chunk of that would be welcome, but not transformative.

Six weeks ago the monetary policy committee pledged to maintain its current stimulatory monetary settings until it is “confident consumer price inflation will be sustained at the 2 per cent per annum mid-point of its target and that employment is at or above its maximum sustainable level.”

To meet those requirements, it said, “considerable time and patience” would be needed.

On the inflation front, ANZ’s business outlook survey for March found a net 73 per cent of firms reporting higher costs. A net 47 per cent said they intended to increase their prices, historically a very high level.

Some of that will be tradables inflation such as higher oil prices or Covid-related bottlenecks in supply chains, which the Reserve Bank will regard as temporary and not the kind it should respond to.

Other influences are ambiguous in their impact. For example a higher minimum wage will represent a cost increase for some firms, but a boost to their customers’ incomes for others.

The threatened increase in rents would push that 10 per cent of the consumers price index higher, but that effect would be offset by the disinflationary effect of crimping how much people who rent have left to spend on other things.

Overall, the Reserve Bank, like its international counterparts, has struggled for years to get consumer price inflation back up to its perceived sweet spot of 2 per cent. It may well see a period of overshoot as welcome, lest inflation expectations become anchored too low.

As for the other leg of its mandate, that it contribute what it can to maximum sustainable employment, recent data challenge the bank’s relatively cheerful conclusion in February. The labour market had proven surprisingly resilient, it thought, even though “We currently assess employment as still being below, but closer to, its maximum sustainable level.”

It said 10 of the 14 indicators of labour market conditions it looks at had tightened in the December quarter. They would have included the increase of 19,000 or 0.7 per cent in the number of people employed from the level a year earlier, according to the household labour force survey (HLFS).

It is a different story if you look at the numbers Statistics New Zealand reports based on PAYE returns employers file every payday. In the three months to February 2021 the number of filled jobs was almost unchanged (500 fewer) than over the same three months a year earlier, that is, before the border was closed and the level 4 lockdown imposed.

And some people will have held more than one of those jobs.

That measure of employment growth, or its absence in this case, is not subject to the margin of sampling error which inevitably surrounds survey-based data like the HLFS.

And unlike the HLFS it includes employees who do not live in New Zealand, such as seasonal horticultural workers or people here on working holiday visas. Pre-Covid they represented about 6 per cent of the labour force.

“The labour market is throwing out mixed signals, with firms struggling to find workers, but job-seekers struggling to find work,” ANZ economists said in a recent report.

Both the demand for labour (as indicated by advertised vacancies) and the supply (as indicated by an unemployment rate of 4.9 per cent) have increased, but the skills mismatch is acute.

“On balance we think employment is currently below its maximum sustainable level, even though the labour market has performed much better than expected. Measures of labour market tightness show there is still a way to go before the RBNZ can declare mission accomplished.”

Another factor that ought to deter the monetary policy committee from signalling any tilt towards a tightening agenda is what has been going on in the bond market, in which it is now a leading player through its quantitative easing programme.

Longer-dated bonds, which are heavily influenced by what is happening in offshore markets, especially the United States, have seen yields rise sharply over the past six months, by 1.2 percentage points for 10-year bonds.

At the same time it is expected the Reserve Bank’s purchases will taper off, broadly in line with reduced issuance by the Government as fiscal out-turns better expectations.

It would be surprising if the bank reinforced those tightening trends by signalling a less dovish approach to the short end of the yield curve, where its influence is strongest.

Finally, in the face of all this heightened uncertainty it sees the risks of policy error as asymmetrical.

In other words it would rather have to deal with the consequences of keeping conditions too easy for too long — it knows how to do that — than have to repair the damage of tightening too soon.

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