MNI INTERVIEW: RBNZ To Look Through Temporary High CPI -Conway

The Reserve Bank of New Zealand would be likely to look through stronger first quarter inflation if it was driven by volatile tradables and inflation expectations remain anchored, though a more broad-based, demand-driven rise could bring forward the timing of the next OCR increase, Chief Economist Paul Conway told MNI.

"As long as fundamentals around spare capacity, core inflation, pricing intentions and inflation expectations remain consistent with medium-term inflation falling, because that's our remit, then we would look through it," Conway said in an interview following the Monetary Policy Committee’s decision this week to hold the Official Cash Rate at 2.25%. (See MNI RBNZ WATCH: Breman Notes Dec Hike Risk, Weak House Prices).

 "But if our analysis tells us that it's more generalised, that it feels a bit more like excess demand driving that, if people are factoring it into their outlook for inflation, then that would mean bringing forward the likely increase in the OCR." 

Conway said markets may have interpreted this week’s decision as dovish, but stressed the policy track is little changed from November. Both the RBNZ and overnight index swaps markets see little chance of a hike before December. 

OUTPUT GAP

Conway rejected suggestions the Bank's outlook amounted to a “Goldilocks” scenario. The economy is operating with a negative output gap of around 1.5%, indicating spare capacity that should help bring inflation back to target over the coming year. While GDP growth has rebounded and high-frequency indicators point to continued expansion, Q4's lift in inflation to 3.1% is seen as driven largely by temporary factors, he said.

He noted a relatively small risk that the Bank’s central projection of inflation returning to 2% over 2026 could be endangered if productivity and potential output come in below expectations for 1.5% growth over 2026 and 2% in 2027.

However, Conway stressed that the Bank’s productivity and potential growth assumptions are relatively conservative, and that there is significant potential for the metrics to improve.

"The potential for New Zealand businesses to absorb technologies that already exist and bring their productivity performance towards that domestic productivity frontier is huge ... but that is not baked into our current forecasts for potential output growth. They are more on the bearish side of the range,” he said.

"Population growth is also pretty weak in New Zealand at the moment. That's a big part of the reason why we've got the 1.5% potential output growth in there.”

DOWNSIDE RISKS

On the downside, weaker-than-expected consumption remains a key risk to the outlook, Conway noted. With house prices subdued in real terms, household spending is expected to rely more on labour market improvement than wealth effects.

"We've seen investment pick up ... we've seen some early signs of consumers starting to open their wallets a bit, but we're projecting that to pick up over 2026 as the labour market improves. And that's important, because household spending consumption is over 60% of the economy. So that needs to happen if we're going to see those reasonable growth numbers going forward."