RBNZ goes the BoE way

After months of deliberations, RBNZ does go the BoE way. I had mentioned earlier that RBNZ had not been raising rates despite rising inflation and is more concerned with falling growth. It had paused its interest rate stance and finally gave to the falling growth pressures. It has cut its interest rates in its latest meeting from 8.25% to 8.00%.

Allan Bollard, Governor explains:

“more unpleasant international news has emerged since the June Monetary Policy Statement, and there is a risk that the domestic economy will slow further. Moreover, the cost of funds raised abroad by banks has been rising in recent months as the international financial situation has deteriorated.  Today’s cut will help to mitigate the effect of these increases on the actual borrowing costs paid by firms and households. 

Though inflation is expected to continue breaching the 1% – 3% target:

Recent oil and food price increases mean that annual CPI inflation should peak around 5 percent in the September quarter of this year.

However, just like BoE, RBNZ expects declining growth to moderate inflation:

 However, we expect that inflation will return inside the target band in the medium term. The weaker economy is expected to reduce pressure on resources, making it more difficult for firms to pass on costs and for higher wage claims to be agreed.

It also indicates strongly that future rate cuts are highly likely:

Consistent with the Policy Targets Agreement, the Bank’s focus will remain on medium-term inflation. In this regard, it is important to note that monetary policy has been reasonably tight for some time, and is now restraining activity and medium-term inflation pressures. Provided that the outlook for inflation continues to improve and there is no excessive exchange rate depreciation, we would expect to lower the OCR further.

I had mentioned earlier and had praised RBNZ for continuing to fight inflation. However, had also indicated it will be interesting to see if RBNZ goes BoE way or carries on with its inflation fighting ways. There are couple of points to ponder:

  • How can the inflation targeting central banks can walk away from their inflation targets and instead concentrate on falling growth. I can understand if inflation is declining but it isn’t. IMF recently raised its inflation projections for 2008 in most countries.
  • RBNZ says it will look at inflation in the medium term and expects it to decline in that term. Now medium term is nothing but a sum of short-terms and if inflation persists in the short-term, it is expected to be the same in the medium term as well. The reason is inflationary expectations thern creep in the inflation numbers and  what we see is an inflation spiral.
  • I am really confused with the numerous projections going around. IMF in its recent forecasts has revised growth projections upwards for most countries, though RBNZ expects a slowdown in NZ. The economic activity numbers for US have been surprisingly positive and this has led to revision of forecasts. I am wondering whether same could also be the case for NZ as if US picks up, so would other economies.

It is fascinating to see the IT Central Banks function in these times. It surely makes you question their role and actions. I think we claimed success of IT Central Banks too early. These times should make them (and us) rethink of the current framework.

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