May Monetary Policy Statement and Official Cash Rate (OCR)

Adrian Orr: Kia orana tatou katoa katoa. Tēnā koutou katoa And welcome to Te Pūtea Matua, the Reserve Bank of New Zealand and thank you for making the effort to be here for our press statement about the May monetary policy statement. I will do my usual unpaid advert. Please read, please absorb, please learn. Please share. Please promote. It has an enormous amount of rich information to make people financially literate and more aware of the economic environment around them. I want to thank the staff and Monetary Policy Committee for supporting the decision today and I am the chair and spokesperson on behalf of the Monetary Policy Committee. It always feels unusual that it felt so difficult to leave the OCR unchanged. So, here we are again at 5.50% for the official cash rate. I'm very pleased that restrictive monetary policy has reduced capacity pressures in the New Zealand economy and lowered consumer price inflation and we remain confident that annual consumer price inflation is expected to return to within the one to 3% target range towards the end of this calendar year.

The welcome decline in inflation in part reflects lower inflation for goods and services imported into New Zealand. Globally, consumer price inflation has declined from 30 year highs. We have not been alone in this global inflation battle that's across many advanced economies and, like here in New Zealand, services inflation is receding slowly and expected policy interest rate cuts continue to be delayed. This is not unexpected. We are in the last stages of a disinflation process. In New Zealand, pressures in the labour market have eased considerably. Businesses are employing much more cautiously in line with the weak level of economic activity, while the number of people available to work has increased due to the high net inward migration of recent times. Wage growth and domestic spending are now easing to levels more consistent with the Committee's inflation target range. While weaker capacity pressures and easing labour markets are reducing inflation, this decline is tempered by sectors of the economy that are less sensitive to interest rates.

Again, this is as expected, but we are at that stage where near-term factors such as higher dwelling rents, insurance costs, council rates, and other domestic services price inflation slow the pace of disinflation. A slow decline in domestic inflation always poses a risk to inflation expectations. A lot of people build what they think about the future for inflation based on what they're currently experiencing and that persistence is always a concern for central bankers. Our economic projections include only officially available information on the government's fiscal intentions to date, which includes the most recent fiscal update and the mini-budget. In our projections, the signalled lower government spending is currently unexpected to continue contributing to weaker aggregate demand.

Looking ahead to next week and any impact of potential changes in the forthcoming budget to government spending or private spending, in part related to possible tax cuts, will remain to be assessed. And when I say assessed, we will get the details like everyone else. We will be putting that through our frameworks and we will need to observe economic behaviour and changes to whatever those announcements bring. Annual consumer price inflation remains above the committee's one to 3% target band at present at 4.0% and components of domestic services and inflation persist and largely on that basis the Committee agreed that monetary policy needs to remain restrictive to ensure inflation returns to our target band in a reasonable timeframe. Just before I move to taking questions, I want to first of all welcome publicly Carl Hanson who has joined our Monetary policy committee. This is Carl's second meeting, first full meeting.

He was with us in the April monetary policy decision. Wonderful to have you back involved with us, Carl, and for your support. You will hear and see from Carl for years to come and I want to sincerely thank Caroline Saunders who finishes her term on the Monetary Policy Committee today after over five years of service to your country with the heavy blanket of monetary policy decision making back in 2019, to think of the roller coaster ride we've had would've been unthinkable. So, thank you so much for your strength, courage, patience and time and wisdom. All the very best back there on the mainland. Wonderful. So with that said, I do want to say that Professor Prasanna Gai will be joining us... Excuse me. In July as a replacement for Caroline Saunders and with all of that said, welcome again. We're open for questions.

Media questions

Media: Thanks. Tom Pullar-Strecker from the Post. We're seeing in these forecasts a more pessimistic outlook for inflation and also a slightly, very slightly, more pessimistic outlook for unemployment as well. That doesn't seem cheery. What's the sort of phenomenon that explains that?

Adrian Orr: The first part is inflation. We are down at that slow moving less interest rate sensitive component. Those domestic services, I outlined a couple of examples and monetary policy works indirectly to influence that. A lot of prices may already be indexed such as various taxes and the rates, the insurance, those stories we know well, that will take time for those inflation rates to decline. This is the story internationally as well. It's the last parts of that monetary disinflation. On top of that, we have done a few things as we learn as we move through. One of them is around the potential growth rate of the New Zealand economy. We've been experiencing cyclically low productivity growth, which is weighing on the potential economic growth of the country, which means, for any level of aggregate spending, there is more likely inflationary pressure. And so, lowering the potential growth rate adds to that.

Why have we done that? Because we have been learning as we go and it better explains the persistence we've seen in domestic inflation to date. We are operating with a vehicle that can move slower on average without generating inflation around that productivity. We opine in here around whether it's temporary or something more permanent. Definitely, there are temporary components. Firms work quick to employ and hoard labour after those acute extreme labour shortage periods once the borders were reopened. And so more inputs, same outputs equals less productivity. We expect to see a lot of that unwound and we are observing that now. The labour market loosening considerably on that side and the more permanent issues, well... That's back in the buckets of competition and the shallow capital structure of the New Zealand economy. Those would be the main components that are there.

Media: Thanks. A quick follow up. I mean, we're seeing a really big gap open up now between your expectations for the timing of monetary policy easing and the commercial bank's expectations. Does that concern you?

Adrian Orr: No, we work very closely. We like to hear and learn all information. Commercial bank economists will provide information. Actual market pricing provides information, but we are the ones who are responsible for delivering low and stable inflation. The good news is we get to do it every six weeks and continue to learn as we move just as many of the commentators have.

Media: Lucy from Reuters. The OCR track theoretically implies an 80% chance of a hike by December. Do you really think we could see a hike by December?

Adrian Orr: I don't buy into that theoretically implies. That's spurious accuracy around a forward projection. So, we're saying the official cash rate peaks at around 5.6%, there or thereabouts, and it's likely have to remain in a restrictive level for some time yet.

Media: But if you consider you're more confident about inflation coming down or back to target, why is a hike even a possibility?

Adrian Orr: We have limited upside room for inflation surprises. That remains the case. We are at 4%, we are disinflating, so there is that asymmetric risk tolerance that we have because of where we're at, where inflation expectations are, we need to win the day and I've already explained around where aggregate demand is relative to aggregate supply. It's just broadly matched now and the capacity of the economy, the potential output, is lower than we were thinking. So nothing is... We are confident we will get there because we know we are restrictive. We just don't want to be mucking around with how long it takes to get there because of price setting behaviours.

Media: We've seen inflation expectations full in the last couple of surveys. Is this something that you're looking at? Is it going into those considerations? If inflation expectations are coming down, why is that not reflected in us thinking that inflation is going to come down?

Adrian Orr: Yeah, absolutely. It's reflected and we're really, really pleased. We need to see more of that. We need to see inflation expectations to continue to decline and be fully anchored around our 2% inflation rate. There are many measures of inflation expectations. Our business survey ones are very well-behaved, wise price setting people within firms, but that's not many people within the broader economy. Household surveys of inflation expectations persist above and likewise, many, many other indicators of inflation price and wage expectations still have a little way to go. So, we're really pleased where they're going. We were reminded by a photo during our meetings where the cyclists raise their arms, just short of the finish line, and then came second. We are keeping our hands on the steering wheel.

Paul Conway: Can I please just echo the governor's comment that that 80% chance of a hike in the future is indeed spurious? It's based on... For that to happen, the economy would have to evolve exactly as we have modelled it and there's so much uncertainty in the data, there's so much uncertainty and economic relationships that we know that is not the case. So, your 80% is conditional on something that has a relatively low productivity around being exactly as we've modelled it in this [inaudible 00:12:21].

Adrian Orr: The committee does not think in that space at all. It makes good copy for some financial forecasters.

Karen Silk: Yeah, look, it's a central projection and, as articulated in the documents, there's risks to the upside that Adrian's talked about. There's also risks to the downside to that as well. And so, that's why it's a central projection. It's not an absolute.

Adrian Orr: Our confidence is stronger over the horizon that matters most to us, which is over that 18 months to two years because we are restrictive so we know we'll get there, but between now and then, there are unders and overs that we know we are going to have to weather and remain focused.

Media: Jenny Ruth from Good Returns and Just Business. I do have a question, but can I ask you to direct the PR staff to start sending the invites to these things? They've been refusing to for the last year and it's pretty petty if you ask me.

Adrian Orr: Okay. Oh no, I apologise. Yes, thank you. You are always invited. Jenny, you've got a permanent one from me.

Media: Thank you very much. The projections imply that you've pushed out the next rate cut from about the June quarter into possibly as far as the December quarter. What are the factors that caused you to think that was necessary?

Adrian Orr: A combination of many things that we talk about on the document. One was a slightly higher starting point, particularly for domestic inflation. We anticipated non-tradables inflation would be at 5.3% by Q1. This year it's at 5.8%. That's a significant different starting point for inflation, more work to do on that part that is hardest to budge. The second part is the lower potential output. That does matter for us. All of that adds up in a modelling sense to have to stay restrictive for longer. I deliberately use that word in a modelling sense because when we're back next time the world changes again and the inputs change again and who knows where that goes. This is why we do the repeat game. In that central forecast, we make lots of bold assumptions around inflation, inflation expectations, so on so forth. Labour market behaviour, which could turn out to be fundamentally different, so we will need to stay awake and aware.

Paul Conway: Can I just clarify please that the OCR in this model-based track does peak at the end of this year and starts to decline early next year? It goes beneath where it is currently at 5.5% in the third quarter of next year.

Media: When I looked at the quarter by quarter CPI forecasts or projections or whatever you want to call them, there were quite a few quarters that remained the same. A few went up and towards the later period, there are a couple that go lower, but it doesn't seem dramatically different from February.

Adrian Orr: That's because the inflation forecasts are endogenous and it's the interest rate path that has changed.

Paul Conway: It's other variables in our model that move around so that we achieve our remit.

Media: Thank you, governor. Luke Malpass, the Post. In your interesting discussion here about productivity, I noted there's a little line where you say basically government spending is higher as a proportion of potential output than it was in February. So, I suppose, as a matter of technical practise, if the government wanted to be having the same disinflationary effect that it was having in February, it would have to reduce its spending more. Is that sort of what you're saying?

Adrian Orr: That's exactly right. I mean, the government spending is dollar x. It remains the same. It's just that it's now potential outputs declined. So, it's now a larger part of the economy. It's important to note that the government spending as a percent of potential output continues to decline, has done and continues to throughout the forecast. It's just declining less than in February. So it's less disinflationary. Sorry, all the double negatives.

Media: That's all right. And not withstanding what you've said about budget information that's out there in the public domain, just on spec, what are the sorts of spending or initiatives that the bank might be keeping an eye on next Thursday? What are the key things that you are sort of watching?

Adrian Orr: Yeah, so aggregate spending, aggregate demand, aggregate tax, those are the big variables that matter for monetary policy in large. And so, as we've talked about here, government spending and investment as a proportion of total potential output is really important to determining the impact it has on inflation disinflation. Likewise, whether it is incentivizing or disincentivizing changes in private spending behaviour, whether it be wages consumption or investment so the big variables there.

We have very accurately worded, I think the best paragraphs to refer to are in our record of the meeting where we talk about the government's fiscal policy in total. And then we talk about how it matters for monetary policy. One is that potential output story. The other one is just the timing between government savings and government spending. These things can also have, at the margin, different implications for inflation pressures and monetary policy. So, we need to wait and see and dissect it like everyone else does around. What are those implications? For this document, we have only what's officially known in that we have a continued government spending decline as a percent of potential output, but we have nothing about any potential future government changes in spending or changes in taxes and implications.

Media: Jenée Tibshraeny from the Herald. Just following Luke's questions on tax cuts, I don't suppose you have a view on how inflationary, just the kind of optics around tax cuts might be. So, of course we get to find out the level of income tax, those bracket adjustments, we get to find out what they're going to look like. But having a government that has been talking so much about tax cuts, tax cuts, is there a chance that actually is inflationary just that sort of messaging people feel more confident and perhaps spend more than they might otherwise? Is that something you've thought about?

Adrian Orr: It's certainly encouraging for domestic spending behaviour, if you're cash constrained and think you're going to get a little bit more free cash flow from a tax reduction, then you're less cash constrained so without doubt. But it depends on how that cash was freed up. So, you have to think there's a combination of things that need to be taken on. First of all, what is the source of that spending, of the ability of... The tax cut and the source? If it is fully funded by a reduction in government spending for the tax cut, then over a reasonable period it is fiscally neutral.

That's a really obviously starting point. If it's funded by new money, new debt or something, then that's different. So, is it fiscally neutral over time? And then the next question is how is it being delivered? Are the reduction in tax spending over a long period and tax reductions implemented and aligned? You need to work out a lot of net-nets. For us, we need to do that work. We need time to observe behaviours changing, and then we need to see how relevant it is in both magnitude, but also relative to all of the other things that will change between now and over the next few quarters. So, that is, to boldly say it's a or B, would be naive.

Media: Sure. And then banks have been cutting mortgage rates a tiny bit and TD rates as well recently. Are you comfortable with the level of cuts that have taken place?

Adrian Orr: Yep, they're all factored into what we do. It's the effective mortgage rate that the marginal borrower is facing is what most happens, most impacts that part of the transmission.

Karen Silk: Yeah, there's a couple of things that we look at. First of all, what's the stock? What's the average rate on the existing stock? It's around, bit over 6%, we still see that going through to about six and a half by year-end. Second thing is, just in relation to banks moving rates around, that's part of being in a competitive market and banks will make different decisions based on their own positions at a particular point in time. The kind of reductions that we've seen are still within the realm, as Adrian just said, of the levels that we anticipated them to be at given, where the OCR is sitting today.

Media: I actually just have one more, sorry. I note the new committee member. [inaudible 00:22:32] Just wondering if you can comment on how the vibe of the meeting might be different given the change of composition of the committee. I'd like [inaudible 00:22:45] I'm doing a vibe check.

Adrian Orr: It's wonderful. Carlo's hit the ground full noise. I kind of feel strange by having to talk about... Carlo's staring straight in front of me and you can only see the back of his head, but Carlo's a very professional economist who has had experience in the Reserve Bank in the past and has stayed in the economic profession throughout his full working career, operating at a very high level of decision-making and advice. I think the phrase is a duck to water, which is great. And we haven't lost the great vibe of Caroline yet, so I'll report back next time.

Media: [inaudible 00:23:34] Governor Dan Brunskill from Interest. I was wondering how seriously did the committee consider raising interest rates this meeting and what was it that stayed your hand?

Adrian Orr: Yeah, a real consideration. So, we don't write that down unless it was the record of the meeting is exactly that. We spend a lot of time talking about are we going to get there quick enough? Are some of these near-term price pressures that we know, upward price pressures, just going to persist too far? Are we getting the purchase we need on the economy given the lower potential output in that capacity story that we talked about? Som from the starting position of where we were then to have those things happen to us really make you sit back and go higher starting point for domestic inflation, lower capacity pressure, continued persistence. [inaudible 00:24:31] What we came to is that a lot of those are near-term factors over the medium term over what matters for us. Monetary policy is unambiguously restrictive. The economy is unambiguously very low in the level of economic activity and the output gap is growing. So, we know we are going to get there. That was the balance of risk where we thought no, patience still, but that gives you a sense of the challenge around the table.

Media: Tom Pullar-Strecker from the Post again. Catholic economics has just described that implied forecast from the OCR track that won't be eight cut until Q4 next year as a calculated bluff. I guess you would've heard that sort of suggestion before. What's your response?

Adrian Orr: I don't have a response since... I don't know. They can go and make a book. I don't know what they do.

Media: Sorry, Dan Brunskill from Interest again. I've got more questions. It was interesting that there was a box B in there that talked about the responsiveness of different parts of the economy to interest rates. I just wondered for what purposes have you included that and what does it mean for policymaking if parts of the economy aren't responding, they're the ones that have inflation, is there any point in raising interest rates?

Adrian Orr: Fantastic question and thank you for asking that. Box B is there because we had a box A but it really was a way of us learning and us explaining to people what the next couple of years will feel like and why the last... You can get from 7% to 4% inflation pretty quickly, getting from four to two can be slower and will be slower. That's not slower than expected. It's just slower as normal because you're down.

You're away from the goods inflation, the tradable noisy stuff, the energy, the food prices. You're now down around the domestic side of the economy, which is less competitive, which has indexation where when you're at low inflation changes in relative prices can be quite impactful on headline inflation. And so, we were showing you the bits that are there. I gained confidence personally from looking at those diagrams because it showed a big component that has been really persistent on domestic inflation has now largely dissipated and that is the cost of building houses. But what is left now is insurance and rates and rents and they've all got their own independent stories that eventually monetary policy will win the day, but they are just less sensitive over time. There is a limit to rate increases, there is a limit to insurance increases.

Media: Is that a factor in why you have chosen not to lift rates further because if you did, you would basically whack the parts that have already responded and not so much touch the parts [inaudible 00:27:37]

Adrian Orr: Yes, I mean, that's right. We know that we are achieving what we need to achieve. The pace seems reasonable. We didn't find any OMG moments when we were dissecting those components of services inflation. In fact, we got right down into the nuts and bolts of the consumer price index and what matters. We then did the compare and contrast to the rest of the world. And gee, guess what? That's exactly the same. When you look across Australia, you look across the US, you look across the UK, Europe, it's the domestic services, primarily, with only slightly differences around which components of that.

Media: And my last question, if I can, is just... You've flagged that low productivity is a big problem with inflation getting worse because productivity is falling even faster than inflation is. How does high interest rates affect productivity and is there anything we can do to boost productivity?

Adrian Orr: Yeah, so high interest rates aren't... Monetary policy affects the nominal side of the economy. It's real policy. It's businesses, investing, businesses to be incentivized to invest, innovation, higher capital inputs, all of these things that determine the productivity growth rate, that determines the potential pace of the economy. What monetary policy can do is let inflation get away and destroy the signals for people to spend and invest so that's why we are given the productivity story, we work around it. We can probably do more damage than good to the productivity story by letting inflation get away.

Paul Conway: I would argue, Dan, that low and stable inflation is the best contribution that we can make here to lifting New Zealand's productivity performance.

Adrian Orr: So it's the outcome, not the instrument. Wonderful.

Media: Hi, Jenny Ruth from Good Returns and Just the Business again. Have you looked at why the RBA's cash rate is lower than yours when arguably, you could say, Australian inflationary outlook is even worse than ours?

Adrian Orr: We certainly look across the world for what are the different components and drivers then the reaction functions are idiosyncratic to the central banks. So, I won't comment on the RBA's sides there. They've had very similar inflation type shocks. They've been a little bit better off. They had very high energy price shocks given the nature of their products. They've had that come back given the nature of their products but you will have to talk to the RBA about that.

Karen Silk: Look, I would just add one thing though. There are some structural differences as well, and in particular one of those is transmission, where we have 80% plus of mortgages in New Zealand on fixed rates so, a slower rate of transmission. They have the reverse of that. They have 80% on floating rates, so their ability to transmit is quicker. But then if you look at the comparative mortgage rates, you will find that they are not materially different. And so, you've got a similar kind of transmission running through that economy.

Adrian Orr: And dare I start the last bit, and this really hurts to say, and productivity is probably different in Australia than New Zealand.

Paul Conway: I mean, the US is the best example of positive productivity shock.

Adrian Orr: Strong productivity growth, hence less inflation per dollar spend, so on and so forth. So, let's get moving. Let's get productive by closing this press conference. Jenée, one lucky last? Oh, sorry.

Media: You're missing the [inaudible 00:31:14]

Adrian Orr: Oh, well, I was so upset about Jenée. I wanted to see myself. I can't win.

Media: Don't worry, I'm getting my invites. Investors are still pricing at least one cut by the end of the year. Why aren't they listening to you?

Paul Conway: It's their job.

Adrian Orr: Well, I think they do listen eventually. That's the weight of money. That's them taking a view. If we do cut, congratulations to them. If they don't, then they just have to back off. It's as simple as this. Remember the beginning of this calendar year, the US Federal Reserve and the US economy, they had seven interest rate cuts priced into the [inaudible 00:31:53]

I think you were lucky to have, I'm going to be wrong, but one or two left priced into the [inaudible 00:31:59] this year. So, markets will pick 15 of the next two changes. That is the nature of markets. They buy and sell, they make bids and offers, they trade so that's the story. Likewise, across the economists, it was nicely said, no one... They all think different. No, they don't. There's a big spread across the New Zealand economic group. One bank was taken absolutely to task for making a call a while back by the very people on this room around interest rates and others... So, you've just got to take a view. We don't have to, we're back every six weeks. We're just putting our best foot forward.

Media: And because TVNZ isn't here today, I'm asking a question on their behalf. There's a line in the statement about concerns about the labour market. Are you worried about unemployment rising too quickly and what impact is that having?

Adrian Orr: For us, we would love the optimal world for monetary policies, inflation expectations for actual consumer price inflation declines and everyone remains fully employed. That doesn't happen. So, unfortunately at times, part of the slowing and aggregate demand means slowing in employment and hence rising unemployment or participation. We have unemployment rising to 5.2%, which is a long way from where we currently are in recent experience. It's low level to where we have been in a long historical experience when we didn't get on top of inflation. What we will always be cautious of is, I suppose, a sudden fall in confidence that leads to unnecessary labour shedding just as it led to unnecessary labour hoarding in recent times. We've always just got to be aware of those risks. In terms of financial stability, we have real empathy for households who are doing it hard. This is part of the disinflation process, but we are really pleased to report our financial institutions are sound, profitable, well-capitalised and able to assist and support these people through these periods. It's just part of the job.

Paul Conway: Can I echo the Governor's comment there? The sooner that price and wage setters in the economy adjust to a low inflation environment, then the less unemployment will increase over the coming quarters as inflation.

Adrian Orr: So, that is a call-out to all price setters, local councils, insurance, anyone else that you can list or name, coffee shops. We are going back to a low inflation environment. On that, call to arms and call to productivity. Thank you very much again everyone, and we'll be back.