Reserve Bank's McDermott confirms rate cut possibility to stoke moribund inflation

The Reserve Bank still expects to cut interest rates further to try to stir inflation that's been kept low by a weak global economy.

The bank isn't concerned consumer prices will start falling as a result, bank assistant governor John McDermott says.

In a speech to the Bay of Plenty Employers and Manufacturers' Association in Rotorua, Mr McDermott says monetary policy will continue to be accommodative for the time being and, on current projections, more easing is needed to lift the consumers price index.

The bank's forecast for annual inflation in the September quarter is 0.2%, though its margin of error means annual CPI could be between zero and 0.5%, before rising to the lower end of bank's 1-3% target band in the December quarter, he says. Annual CPI was at 0.4% in the June quarter.

"Interest rates are at multi-decade lows, and our current projections and assumptions indicate further policy easing will be required to ensure that future inflation settles near the middle of the target range," Mr McDermott says.

The kiwi fell almost half a US cent after the release of the speech notes and recently traded at 70.64USc.

The Reserve Bank wants to avoid subdued inflation expectations bedding in, a task made difficult by a strong kiwi dollar making imports cheaper, while a rampant housing market means lowering rates too much could destabilise the financial system.

Mr McDermott says monetary policy has long lags, which is why the bank targets inflation a year or two ahead, and "lowering interest rates now would do little to change" near-term inflation.

A weak global economy has spurred low interest rates around the world and prompted central banks to take unprecedented quantitative easing programmes, which has stoked demand for the New Zealand dollar, which Mr McDermott says is a key factor in headline inflation remaining subdued.

At the same time, a slump in global oil prices made fuel cheaper but doesn't appear to have made a "material or permanent change" in domestic inflation, he says.

Record migration expanding the labour supply has made New Zealand's economy able to grow at a faster pace without generating significant inflation, which Mr McDermott says is a "key structural development" in driving persistently weak inflation.

Despite these changes, the bank doesn't see "any significant risk of deflation in New Zealand," which typically causes consumers and businesses to delay buying things or investing, leading to further price declines.

"Deflation is particularly concerning as monetary policy eventually reaches a point where it cannot go any lower in order to stimulate the economy," he says.

(BusinessDesk)

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