MNI: Energy Shock, Stagflation Risks Cloud RBNZ Policy Path

New Zealand is very exposed to a prolonged energy shock if the Middle East conflict persists, though the Reserve Bank’s response will be difficult to predict as it confronts mounting stagflationary pressures amid an uncertain geopolitical backdrop, former staff told MNI.

Michael Reddell, independent commentator and former RBNZ special adviser, said the Bank could consider cutting the 2.25% Official Cash Rate as early as July if the government resorts to diesel rationing, while the Bank should have a clearer view of the conflict’s economic impact by the May meeting.

"Two months from now, conditions will likely have either begun to turn the corner or supply constraints will have clearly crystallised," he said, pointing to Governor Anna Breman's presentation on Tuesday that left the door open to either hikes or cuts. 

"Diesel demand is incredibly inelastic – if shipments to New Zealand begin to dry up, the only way to allocate reduced supply would be through sharp price increases or rationing, both of which would have severe near-term economic consequences," he added, noting the only two other periods in the past 50 years when diesel consumption fell were during the global financial crisis and the Covid pandemic, when usage dropped about 10%.

Such an adjustment would require significant real economic dislocation and likely large price increases, undermining broader confidence and taking time to recover from, he argued. "In that scenario, rate cuts would become more likely than hikes."

Reddell added that Breman's speech, while straightforward, did not address the risks of a prolonged conflict. The Bank is still digesting recent GDP data, with the output gap likely more negative than previously estimated, while PMI and PSI readings have also softened, he added. Forming a complete assessment ahead of the May meeting will be challenging, he said, adding that an April move appears highly unlikely.

HIKE CHANCES

Markets are pricing a higher OCR in the second half of the year, reaching around 2.95% by December, a fact Leo Krippner, research fellow at Singapore Management University and a former RBNZ senior adviser, believes is closer to reality due to the rate's low level leading into the conflict. 

Krippner, reiterating his view that the neutral rate is closer to 3.5%–4%, argued that the RBNZ had over-eased. (See MNI INTERVIEW: RBNZ's Neutral Estimate Too Low - Ex-Economist) Prior to the oil shock, Krippner saw risks tilted toward second-half tightening given the low starting point for rates relative to neutral and signs of a nascent recovery. However, the conflict will drive RBNZ caution, making Q3 increases more likely, he added. Markets see the OCR at around 2.70% by the September meeting. 

The inflationary impact of the oil shock remains ambiguous, Krippner noted. If the drag on growth outweighs inflationary pressures, that would argue for easing, but should second-round inflation effects dominate, that would support tightening. "It is still too early to determine which dynamic will prevail," he continued. While easing is possible, he said, it would be a significant call.

Globally, the outlook remains similarly uncertain. While there are arguments for both holding or easing policy, it is easier to make the case for higher rates, he added. But, until the balance between growth and inflation becomes clearer, policy direction will remain uncertain, Krippner argued.

Reddell added that if oil market disruptions prove short-lived and supply chains normalise within months, the RBNZ could face a situation similar to the Reserve Bank of Australia, which hiked its cash rate to 4.1% last week. "Yes, there's some backdrop stuff there, but the fundamentals might still warrant a rate hike. I don't really believe it, but it's consistent with the view that the bank was running in February."