Reserve Bank – sticking to its guns with superglue

When it comes to that old saying about 'sticking to your guns,' Reserve Bank governor Graeme Wheeler is inclined to apply superglue to his palms and his rifle butts.

What was expected from New Zealand's central bank this morning was, perhaps, a cautious drift away from the previous "neutral" outlook on the official cash rate.

To translate this from the original economic Aramaic language, what that means is Mr Wheeler had earlier indicated the next move on the official cash rate could up either up or down and, in any case, no move was likely until 2019.

Most economists, in their disputatious way, saw this as not likely to happen. With the economic growth running either above the long-term trend or close to it, and with the official cash rate at a historic low of 1.75% and price inflation on the rise, the next move could only be up.

The Reserve Bank monetary policy statement which accompanied the decisions to hold the OCR at 1.75% essentially lays out why it doesn’t think a hike is a given.

The consumer prices index might be at 2.2%, something that would, on an upswing, normally have the Reserve Bank starting to apply the monetary brakes.

But it does not expect that upswing in prices to continue.

“We are expecting to see lots of volatility in inflation over the near future,” the bank’s chief economist, John McDermott, told a media briefing.

“But underlying inflation will remain low.”

Such a firm confirmation of the neutral stance clearly confounded the currency markets: the New Zealand dollar took a tumble within seconds of the announcement.

A raft of factors has been holding inflation down: oil price tumbles and strong immigration keeping wage inflation down being two big ones.

The Reserve Bank expects immigration to come off recent highs, and for that reaction to keep wage inflation from surging in the way it would have under similar conditions in the past.

That does not mean a pickup in wages inflation is not expected – it is. But that pickup is not large, moving from 1.6% to a little more than 2%.

Meanwhile, the outlook for the currency remains critical. It is expected to follow recent reductions – and today's sharp drop will no doubt have central bank officials purring.

But even if the exchange rate were to head upwards, the reasons for it rising will make all the difference as to what direction the Reserve Bank moves in.

An exchange rate surge because of a weaker global outlook would be more likely to see the Reserve Bank cut the OCR or at least not raise it.

An exchange rate surge because of a stronger than anticipated New Zealand economy, on the other hand, would cause an official cash rate hike: such a pickup on what is already an above-trend growth path being projected would feed quite quickly through into inflationary pressures.