Peter Nicholl
The Reserve Bank surprised almost everyone by raising the Official Cash Rate by 50 basis points on April 5.
In the preceding two weeks, both the Bank of Canada and the Reserve Bank of Australia had decided to leave their policy interest rates unchanged.
The reasons they gave were that there were some tentative signs that global inflation pressures were beginning to ease, and they needed to allow time for the lagged effects of the interest rate increases they had already imposed to work through and be seen. They also said that the recent signs of financial market disruptions and global economic downturn suggested it was a time for central banks to be cautious.
There are all good reasons for central banks to take a pause in their tightening.
Most of the New Zealand financial markets and media had not expected our reserve bank to match their Canadian and Australian colleagues. But the dominant expectation was that the new evidence was strong enough to convince the bank to increase the cash rate by 25 point this time rather than raise it by 50 as they had on eight previous occasions.
The bank’s explanation for making another 50 point increase confused me. It said it made the aggressive move “to prevent banks from cutting lending interest rates rather than to push them up”.
They went on to say they were “comfortable with current interest rates”. I am not sure what current interest rates they were talking about. Over the next six months, around half of the fixed interest rate mortgages in the country will come up for review and their interest rates are likely to double.
I don’t think it is today’s current interest rates the reserve bank is comfortable with. It is the higher rates many will face over the next six months. The reserve bank was worried that banks may have been thinking about not raising the interest rates on these mortgages as they rollover by as much as they have been doing recently.
So, the reserve bank isn’t really comfortable with current interest rates at all. They want the interest rates in all these mortgages that rollover during the next six months to continue to double. Mortgage holders will feel distinctly uncomfortable about that.
The bank has dual objectives of price stability and employment. The issue of a single or a dual target for monetary policy will be argued during the election later this year. I don’t have a view on this issue in terms of economics. But I do have a view on it in terms of central bank policy behaviour.
A few years ago, the Reserve Bank took their policy settings far too far in an easing direction as they focused totally on the employment objective. They were slow to start reversing these remarkably loose settings when inflation began to reappear, believing the inflation would be transitory.
Now they have swung to the other extreme and are in danger of going too far in their battle against inflation. The Reserve Bank is becoming a destabilising factor in the economy and a generator of economic cycles.
For this reason, I think the bank’s policy focus needs to go back to the single objective of price stability. They have shown they are not capable of juggling the dual objectives.
