Inflation surprise puts heat on new RBNZ governor

Surprisingly good price inflation figures have led to more calls to cut the official cash rate.

New Reserve Bank governor Graeme Wheeler delivers his first OCR review next Thursday and has been widely expected to keep his powder dry until the next full monetary policy statement – with an updated set of economic forecasts – in early December.

However the 0.3% quarterly consumer price index (CPI) figure today takes annual price inflation to 0.8%, below the Reserve Bank’s target band of 1% to 3%.

It is also, as ANZ Bank chief economist Cameron Bagrie points out, the fifth successive quarter in which the CPI has been lower than the Reserve Bank, or most other economists, expected.

There are already calls for a cut from the present rate of 2.5%, not only from the opposition parties and the unions – something which has become normal – but also from the the Employers and Manufacturers (Northern) group.

Drilling down beyond today’s headline figure the picture is a bit more mixed.

First, the main downward pressure on inflation is the high New Zealand dollar.

If the currency comes down – and although it is likely to remain at or around US 80 cents for the rest of the year it is expected to drop somewhat over the course of next year – that constraint will be lost.

Non-tradable sector inflation is still on the increase, up a little more than 2% for the year, with local council rates, house prices, insurance and other house and construction related factors being the main drivers.

Several economists now say a cut in the OCR is more likely, but the likelihood depends on how Mr Wheeler interprets his new policy targets agreement.

That agreement, signed late last month by Mr Wheeler and Finance Minister Bill English, adds a new clause requiring the Reserve Bank to look at asset prices and, in effect, to try to prevent asset price bubbles from developing.

Had such a clause been present in 2005-06, when the mortgage war between the trading banks was particularly lethal, the Reserve Bank would probably have had to hike the OCR much more aggressively than it did.

“We are not calling for a cut. But the odds we would ascribe to such have just ticked a bit higher from the 35% we advocated in our Markets Outlook on Monday. Let’s call it 40%,” Bank of New Zealand economist Doug Steel says.

However, Mr Wheeler may face a conundrum on this, TD Securities strategist Annette Beacher says.

“Todays’ inflation number is good, and I do think the Reserve Bank could cut rates – I think the economy could do with a hand,” she told NBR ONLINE.

“But if Wheeler is meant to add asset price stability to his brief then I think the next move should be up.

"I think the house price inflation issue has blindsided the policymakers. Everyone has been looking at the Christchurch rebuild, but the issue is the Auckland house prices.”

The other factor is the OCR is set not for the last quarters’ data – as this was – but for where the economy is expected to be in a year to 18 months.

As the global uncertainty has become part of the landscape, that means making a call one way or the other on the OCR has got much more difficult, and a “sit tight” approach emerges almost by default.