Treasury sees greater inflationary pressure, higher interest rates

New Zealand’s Treasury sees greater inflationary pressures and higher interest rates as new government policies lead to a faster pace of economic and wage growth.

The policies are “forecast to support a longer period of above-trend economic growth and, consequently, slightly higher inflationary pressure and a stronger monetary policy response,” it said in the half-year economic and fiscal update today.

The new policies include the KiwiBuild programme, aimed at delivering 100,000 affordable homes over 10 years, the families’ package and increased student allowances as well as a lift in minimum wage and other labour market policies aimed at increasing productivity and collective bargaining.

Treasury now expects the economy to expand at an average rate of 2.9 percent per year over the next five years “slightly above the growth rate the economy can sustain before it leads to higher inflation,” it said.

New Zealand’s central bank kept interest rates on hold at a record low 1.75 percent in its latest monetary policy statement and signaled the first rate increases would come in mid-2019 at the earliest given tepid inflationary pressure.

Treasury still expects interest rates to begin to lift from late 2018 “to dampen stronger inflationary pressures.” Also, the 90-day interest rate is now 25 basis points higher over 2020-21 than it was in the pre-election update, it said. This will partly offset some of the fiscal policy-related demand impacts.

Interest rates are also expected to rise quite sharply in the forecast period through the June 2022 from current record lows as the economy picks up steam.  

Its forecasts show the 90-day bank bill rate, often seen as a proxy for the official cash rate, lifting to an annual average 2.4 percent in the 2019 June from 2.0 percent currently and jumping to 4.2 percent by the year to June 2022.  Treasury sees the neutral nominal 90-day interest rate at 4.5 percent in June 2022.

As a result, its forecasts show it expects annual inflation to lift to 2.1 percent in the June 2020 year and 2.2 percent in the next two years.

Treasury did note that things may not pan out as expected. Should growth in labour productivity remain low, and if consumer and business confidence remains weak and there is weaker domestic demand the central bank will take a “more cautious view” of monetary policy settings and raise interest rates more gradually, it said.  In this case, interest rates could be 50 basis points lower than they otherwise would have been, it said.

To the contrary, if global growth picks up faster than expected, adding to demand for New Zealand exports and businesses respond by bringing forward investment there would be increased inflationary pressure and higher interest rates “which end up around 70 basis points higher by the end of the forecast period,” it said.

The government, meanwhile, is mindful of ensuring that its fiscal policy does not place “undue pressure” on monetary policy, said Finance Minister Grant Robertson.  He said running a larger surplus when the economy is strong will help reduce upward pressure on the exchange rate and interest rates, he said.

Treasury’s forecasts show the operating balance before gains and losses will be around $1.8 billion less than previously forecast over the next three years but returns to around forecast levels in the year to June 2021 and will reach $8.8 billion in the year to June 2022. It is forecast to be $2.5 billion in the year to June 2018 versus a prior forecast of $2.9 billion. 

(BusinessDesk)