Stephen Miller
In a widely anticipated move the Monetary Policy Committee (MPC) of Reserve Bank of New Zealand (RBNZ) cut the official cash rate (OCR) by 50 basis points (bps) to 4.75 per cent.
That move followed a 25 bp reduction at the last RBNZ MPC meeting in mid-August.
Despite being well anticipated the shift to bigger cuts represents something of an abrupt change in approach from the RBNZ.
Following the decision to cut at its mid-August meeting RBNZ Governor, Adrian Orr, said the bank intended to move “calmly” and at a “measured pace.”
That the RBNZ choose to move by the larger amount, almost certainly reflects a concern that the NZ economy is mired in a low growth funk with unemployment rising and house prices falling. Accordingly, inflation is declining at a pace greater than previously anticipated by the RBNZ.
As the RBNZ put it, the “New Zealand economy is now in a position of excess capacity, encouraging price- and wage-setting to adjust to a low-inflation economy.”
Is the RBNZ experience a portent for the RBA?
While the NZ experience is salutary one, there are enough differences between the Australian and NZ economic environments and central bank practice that caution against the drawing of too much by way of parallels.
Where the Reserve Bank of Australia (RBA) has differed from other developed country central banks, including the RBNZ, is that it has shown a reluctance to raise rates as far and as fast.
The consequence has been relatively lower policy interest rates than most other developed countries (the RBNZ policy rate is still 40 bps adrift of the RBA policy rate), but relatively better labour market outcomes.
The downside has been relatively “stickier inflation”.
And what that suggests is that in Australia policy rate adjustments on the downside will lag those in other developed countries.
This was implied in the Governors’ press conference on 24 September and very much implied in the minutes released on Tuesday this week.
Economic developments since the last meeting have by and large vindicated the RBA “experiment”.
The RBA Board acknowledged the risk that the ‘pickup [in household spending] is slower than expected, resulting in continued subdued output growth and a sharper deterioration in the labour market.’
There is, as yet no evidence of that ‘sharper deterioration in the labour market’.
Nevertheless, such a deterioration is a non-trivial risk and one to which the RBA would certainly respond.
In my view the RBA may soon be in a position to see some light at the end of the tunnel on inflation.
Tuesday’s release of the NAB Business Survey revealed some “straws in the wind” that inflation has stepped down in a manner that will allow the RBA to more confidently judge that inflation is heading sustainably back to target in in line with the forecasts issued in August. (Having said that, input costs, including labour costs are running significantly ahead of output prices, implying Australian businesses are under margin contraction pressure.)
The NAB Survey also revealed more resilient business conditions including for the labour market and employment.
If, as I suspect, labour market outcomes and inflation outcomes will be broadly in line with RBA forecasts, then the RBA might reasonably expect to cut rates in February.
A deterioration in the labour market may bring that forward to December but that is not a central case scenario.
Coming up: US September CPI
The surprising resilience in the US labour market revealed by the release last week of the September US non-farm payrolls data appeared to have put paid to any notion that the Federal Reserve (Fed) may follow up it September decision to cut rates by 50 bps with another such “jumbo” rate cut in November.
That is probably accurate.
That notion is given some emphasis with the revelation from the minutes of the September Fed meeting indicating a preference among some officials to cut rates at a more gradual pace.
Those minutes noted that “[s]ome participants observed that they would have preferred a 25 bp reduction of the target range at this meeting, and a few others indicated that they could have supported such a decision.”
That same sentiment was evident in the tenor of comments from various Fed spokespeople this week.
There was not much by way of regret in moving 50 bps in September but certainly elevated caution in considering a move of similar size in November.
Such an approach is certainly defensible. Despite some commentary to the contrary from the likes of Mohamed El-Erian and others, I don’t think the decision to go 50 bps should be viewed as a mistake even if I was a little surprised that the Fed went down that path.
Monetary policy was certainly restrictive and with inflation, to all intents and purposes virtually at target (3-month annualised increase in core PCE), it had become difficult to resist a significant easing of that restrictive stance.
And before Friday’s robust report, there were signs of cooling in the labour market.
Market expectations for tonight’s core consumer price index (CPI) see a 3.1 per cent annual increase which would equate to around 2.6 per cent on a 3-month annualised basis. Allowing for differences between the CPI and the core PCE, such a CPI number will allow the Fed to cut the policy rate by 25 bps when it meets on 6-7 November.
In my assessment, it would take a number higher than that to for the Fed to eschew another cut in November. Such a number would be close to 0.3 per cent (month-on-month) which would mean a re-acceleration of annual inflation above 3.2 per cent and 3-month annualised figure close to 3 per cent.
Even then, for the Fed to eschew another cut entirely when it meets in November, would require not just the adverse inflation scenario described above, but probably another solid October employment report to be released on 1 November.
By Stephen Miller, investment strategist
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