MNI INTERVIEW: RBNZ To Eye 2% OCR Level - Ex Assistant Gov

The Reserve Bank of New Zealand is likely to need to cut the 3% Official Cash Rate by 100 basis points over the medium term to stabilise output and inflation following weaker-than-expected Q2 GDP data, a former assistant governor told MNI.

John McDermott, executive director at Motu Economic and Public Policy Research and an RBNZ assistant governor until 2019, said the Bank kept the OCR at its 5.5% peak for too long, after a lengthy period of over-loose settings. “This will require the Monetary Policy Committee [MPC] to hold policy below neutral for some time to compensate and stabilise the economy,” he said, citing weak retail spending, a soft labour market, and Q2’s 0.9% contraction. 

“Holistically, something’s not right in this economy. Once it was clear inflation was coming inside the target band, they should have quickly moved to a neutral stance. Now, because they didn’t, I think they need a compensatory period of easy policy.”

McDermott declined to comment on the likely outcome of the October and November MPC meetings, which markets have priced in as two consecutive cuts leading to a 2.38% OCR by year-end. Traders also see a terminal rate of 2.26% by March.

“The Bank likely felt the OCR was around neutral,” he said, citing August’s meeting and comments. (See MNI RBNZ WATCH: MPC Makes Dovish 25BP Cut, Eyes 2.5% OCR) “It’s not that 2% is where they need to be forever, but they need to get down to that level to stabilise things.”

McDermott warned in May that markets were underestimating how much the Bank might need to ease, citing weak business confidence amid global uncertainty and calling for an OCR around 2.5%. Other former RBNZ officials have told MNI they are more cautious about the prospects for further easing below 2.5%, pointing to persistent inflation pressures. (See MNI: Markets Overestimating Lower OCR - Ex-RBNZ Officials)

SINGLE FOCUS

McDermott noted that while the RBNZ has a single inflation mandate, it still must consider the real economy once inflation is under control. “If the true mandate were only to hit inflation and never worry about anything else, that would be easy,” he continued. “The ultimate aim is to protect the economy. Once credibility on inflation is established, the Bank has more flexibility to support the labour market and output.”

He warned that sticky inflation and local non-market prices, such as council rates, complicate policy. “If rates are too high, declines continue cyclically to be weak, and prices continue to fall elsewhere,” he added.

“The Bank has to manage expectations carefully, balancing the risks of sticky prices with the need to support broader economic stability. Over the medium term, inflation is under control, so now the focus must be on limiting damage to the real economy.”