Opinion: How Does The Reserve Bank Plan To Balance High Inflation and Low Interest Rates?

Rising house prices due to a low-interest regime, good economic growth, employment, and GDP numbers better than other countries are all posing a challenge for the dovish Reserve Bank of New Zealand.

Should the Reserve Bank continue its expansionary stance or have a relook at it?

The Central Banks all over the world have continued with low interest rates even though their economies are beginning to take off. Led by the Federal Reserve (FED), which did not heed to the U.S high inflation numbers, the Bank of England, Bank of Canada, and the Reserve Bank of Australia have all kept the interest rates historically low.

In their monetary policy announcements to date since the coronavirus pandemic, they have kept the interest rates the lowest. Some of the developed countries have even kept the interest rates at zero %.

As they deal with the consequences of the coronavirus pandemic, they are almost united in thinking that a low-interest regime is necessary till the economic recovery is complete.  Earlier, these banks were often quick to respond to rising inflation numbers with an immediate interest rate hike, but not now.

They are taking a dovish stance even though high inflation stares in their faces.

There is much more tolerance towards inflation as there are bigger economic goals, with eyes on full economic recovery.

Some of the Central Banks have been most radical in their viewpoints, moving away from decades of rising interest rates to cool off inflationary pressure.  Instead, for the first time, the emphasis is more on full employment, a strategy that they say will benefit more people. 

RBNZ also takes the same view

The Reserve Bank of New Zealand (RBNZ) has also taken a similar stand. Like in the US, in New Zealand also prices are going to increase leading to inflation.  Expectations are that there will be a huge lift in prices in the June quarter, reflecting in July numbers due to higher oil prices.  Higher oil prices will reflect in every aspect of one’s life.

In terms of employment, New Zealand is reporting strong employment numbers as compared to other comparative economies. A recent report released by Stats NZ showed that the employment had grown in April 2021.

The industries that had the highest number of jobs created were construction (up 7.1%), healthcare and social assistance (up 6.5%), public administration, and safety (up 5.8%) and professional, scientific, and technical services (up 4.4%)

However, several industries like aviation, transportation, warehousing, travel, and postal had more than 5% fewer jobs filled. 

Regional variations were also there in job growth numbers. For instance, the Bay of Plenty and Waikato regions saw the highest growth at 5% and 4.4% against filled jobs data of April 2020.

Other indicators like retail spending and trade surplus are very strong, with New Zealand reporting a higher-than-expected rise in retail sales in the March 2021 quarter.

The latest data from Stats NZ shows that retails sales were marked by a Q-o-Q rise of 2.5 percent last quarter. Retail sales emerged stronger despite the loss of international tourists since early 2020, when lockdowns began. Even the trade surplus was well over NZ$388 M in April 2021.

RBNZ under inflationary pressure

The inflation numbers, growing employment numbers, and other strong economic indicators are posing a challenge to the dovish monetary stand of the Reserve Bank.

The question is should the Central Bank come under inflationary pressure?

Headwinds are pointing towards more room for Central Bank’s expansionary stand. The economic indicators have not yet reached a sustainable level. The employment numbers are encouraging but are still high as compared to the pre-Covid-19 levels. There is uncertainty around the pandemic. With recent coronavirus case surges in Victoria and Melbourne, it is still uncertain whether it is over or not.  

The Central Bank is right when it says that in New Zealand also, the economic recovery has been uneven, with some sectors and regions still under the impact of the COVID-19 pandemic.

While the construction industry has been strong, sectors like travel and tourism are reeling under the impact of the pandemic. The huge revenue losses suffered by this industry have been partially offset by the opening of the Trans-Tasman bubble, but still not up to the expected levels.

Even inflation is temporary as RBNZ governor, Adrian Orr in his second monetary policy statement in May, said that the rising prices for businesses and consumers were short-lived as they were driven by supply chain disruptions, higher oil prices, and disrupted shipping arrangement.  He emphasised that higher prices in New Zealand were temporary and were likely to cool off over the year.

Expect full recovery by next year

The economic recovery in New Zealand has to be full and more sustained rather than a few encouraging indicators for the Central Bank to increase the interest rates. The numbers also point to inflation and employment to be below targets in the medium-term.

Regarding the housing crisis, there is no doubt that the low-interest rate regime has led to an increase in house prices, but the current policies to balance demand and supply announced by the government are likely to show results in cooling off the prices.

Even though some economists are making a case for tightening the monetary policy, the Reserve Bank should maintain low interest rates till the consumer prices, inflation, and employment remained at the target level for some time.

Very clearly, the Reserve Bank of New Zealand should keep the OCR unchanged till the targets for inflation and employment were sustained over a period of time at the remit level.