Economic week

November 10, 2017
by Nick Clark

The Reserve Bank kept the OCR unchanged this week at 1.75%.  No surprise. Also no surprise was the statement continuing its neutral tone, concluding that “Monetary policy will remain accommodative for a considerable period.  Numerous uncertainties remain and policy may need to adjust accordingly.”  This wording has been used since February.

The Reserve Bank expects inflation to pick up due to a combination of the new Government’s policies and the lower exchange rate.  It won’t be too concerned about this as long as inflation stays within its 1-3% target band.  Looking at the November Monetary Policy Statement (also released today) it appears that the OCR will start rising from around June 2019, which is quarter sooner than was expected in the August MPS. 

More significant is how the Reserve Bank will operate in future.  This week the new Minister of Finance re-signed the existing policy targets agreement with the Reserve Bank and signalled a review to reform the Reserve Bank Act, as agreed by Labour and NZ First in their coalition agreement.

The review will be held in two phases.  Phase one looks at adding employment to price stability as an objective of the Reserve Bank as well as a committee decision-making model for monetary policy.  

It’s been a decade since the last formal review of monetary policy, so there’s no harm in taking a look at how it operates and how it could be improved.  A change to decision-making could be one such improvement, provided it doesn’t undermine the Reserve Bank’s independence.  A lot will depend on who is on the committee and how they are appointed.

Adding employment as a goal for monetary policy is not out of step globally and it might not change much in practice, as seems the case in Australia.  But is it necessary?  Has employment been hindered by the current focus on price stability?  

That 247,000 jobs were created in the past two years and the unemployment rate falling to 4.6% would suggest not.  If the Government wants to boost employment further other policy areas are likely to be more effective. And would allowing a bit more inflation to boost employment be a good thing for workers, especially those on lower incomes who are more vulnerable to inflation?

What are the risks?  The merits of adding employment would be seriously tested if the target rate for unemployment were too low or if the two objectives were calling for different monetary policy responses. This would be especially problematic if both inflation and unemployment were high and rising, as both were in New Zealand during the 1970s and 1980s.  Which objective would win out if push came to shove?  

Phase two of the review will look at other possible changes to monetary policy and could go further.  This raises more questions and concerns.  It would be a worry if there was a return to the way monetary policy operated prior to 1989.  In those days the Reserve Bank was not independent and it had multiple objectives.  

Monetary policy was pulled in different directions, depending on whatever objective was considered most urgent and often at the whim of electoral priorities.  The result, eventually, was an economic mess with wild volatility and generally poor outcomes in inflation, employment, exports and economic growth.

The 1989 Reserve Bank Act was a key response and, along with fiscal responsibility, reduced protectionism, and regulatory reform, it greatly improved the state of economic policy which was so important for dragging New Zealand out of its economic mess.  It would be a great shame if this key plank of economic policy were to be undermined. 

Speaking of fiscal responsibility, the healthy state of government finances was confirmed this week in the latest Government Financial Statements for the first three months of the 2017/18 year.

Tax revenue and spending both came in around forecast. There was a $90 million operating deficit before gains and losses but this is relatively small and deficits are not unusual during the early months of the financial year.  Larger than forecast net investment gains meant the operating balance was a surplus of $1.6 billion, $1 billion larger than forecast.  

Core Crown net debt increased slightly in nominal terms to $61.1 billion but was $3.1 billion lower than forecast and the Crown’s net worth was $11.5 billion higher than forecast at $112.1 billion.

Looking ahead, a higher track for government spending will put pressure on surpluses, especially if economic growth (and tax revenue) does not pick up as forecast.  The Labour Party’s fiscal responsibility rules will likely be put to the test if not in Budget 2018 then in 2019 and/or 2020.  

A lower NZ Dollar gave commodity prices a welcome boost, according to ANZ’s monthly Commodity Price Index.

In October world prices were down 0.3% compared to September, with dairy dragging the index down.  Dairy prices were down 3.1% due mainly to rising milk supply in the US and Europe outweighing the effect of a slow start to New Zealand’s season.   

Meat and fibre prices increased 0.8%.  Beef prices were up 1.7% and lamb prices were up 2.2%, but wool prices were down 7%.

With the NZ Dollar dropping in October commodity prices expressed in NZ Dollars were up 2.5% for the month.  This helped ease the declines for dairy to a 0.2% drop and wool to a 3.9% drop.  It also further boosted prices for beef, up 4.7%, and lamb, up 5.4%.

Compared to October 2016, world commodity prices were up 10% while NZ Dollar prices were up 14%.  

Dairy prices continued their run of falls in this week’s Global Dairy Trade auction, slipping 3.5% overall. Whole milk powder had the biggest decline, down 5.5%.  Other prices were mixed, with skim milk powder up 1.8% but butter prices down 3.6%. 

Overall, the average selling price was $US3,105 and 35,072 tonnes were sold.

The GDT Price Index has fallen in five of the last seven auctions and is now back to around the same level as this time last year.  The recent falls will put Fonterra’s payout forecast under pressure but the recent fall in the NZ Dollar is providing an offsetting effect.

Agricultural debt edged up in September but it is continuing to grow relatively slowly, according to the Reserve Bank’s monthly Sector Credit Statistics.  Agricultural debt came in at $60.7 billion, up $137 million (0.2%) on August.  Compared to September 2016, debt was up $1.6 billion, equating to an annual growth rate of 2.6%.  This is up slightly from August’s annual rate of 2.5%, but is down compared to a year ago (3.9% in September 2016).

The annual growth rates in housing debt, personal consumer debt, and business debt all continued to grow faster than agricultural debt.  Annual growth has slowed for housing debt (from 9.2% in September 2016 to 6.6% in September 2017) and business debt (from 8.0% to 5.5%), but growth in personal consumer debt has picked up (from 3.2% to 7.2%).

Exchange Rates

Source: Reserve Bank of NZ

Wholesale Interest Rates