He says the standard concern is that lowering the OCR will add fuel to inflation but that relies on households having spare money to spend and businesses having the pricing power to pass costs on and neither is true right now.
“Some businesses will have to pass on costs, but consumers wallets are already squeezed by the cost of living crisis and burdened by higher fuel costs. Consumer demand is already soft, the economy is simmering, not running hot and it's now cooling again.”
Trass has submitted a paper to RBNZ and Treasury with reasoning for a 0.25% cut to 2% tomorrow.
He says the question is not whether oil prices are inflationary because they are temporarily, but whether the OCR should be held or raised to fight them.
“In a small open economy with anchored expectations, a negative output gap, and demand inflation already returning to target, the answer is no.
“The OCR should be eased, not to fight the price of oil, but to prevent the contractionary shock from becoming a recession.”
In his paper Trass argues domestic inflation depends on demand and little demand headroom exists. An oil price shock reduces purchasing power; it doesn't expand it.
Cutting the OCR in this environment isn't counterintuitive, it's acknowledging where the pressure is coming from and that is supply, not demand, he says.
“The real risk right now isn't too much stimulus by lowering the OCR, it's the risk of not enough stimulus leading to another recession. A recession that a lower OCR can prevent.”
While there is concern that cheaper credit could flow into existing housing stock, pushing up prices just like it did in the early Covid era, he says that is why the RBNZ will have to accompany it with a targeted tightening of investor LVRs and DTIs.
However, new builds will need to be exempt because the country can't afford an interruption to the chain of new dwelling supply.
Trass says by reducing the OCR whilst adjusting LVRs and DTIs for existing homes, the country will get the much needed economic stimulus without the speculative housing side effect.
He argues the OCR is the wrong tool to fight higher oil prices as the price of crude can’t be lowered by raising borrowing costs, but it's exactly the right tool to cushion the demand destruction the shock is causing.
“That's the distinction. Ease the OCR for the contraction, tighten macroprudential for the speculation risk. Two problems, two instruments.”
This paper is one of six Trass has produced in relation to monetary, fiscal, tax and housing policy being submitted to government and publicly released over the next few months.
Rising OCR rates
Although the major banks expect the OCR to be held at its existing rate, they have divergent opinions on when it will start rising.
The ANZ and Westpac expect the first hike in December, while Kiwibank, BNZ and ASB expect it next year.
New Zealand’s biggest mortgage lender ANZ’s chief economist Sharon Zollner says from a ‘first do no harm’ perspective, waiting until the picture becomes clearer is sensible.
“Confidence and cashflow impacts are not theoretical; they are already real.
“Firms are reporting weaker activity, consumers are pulling back, inflation expectations have risen sharply, and interest rates have tightened without any help from the RBNZ.”
She says while the situation is fluid, the bank continues to see policy normalisation kicking off in December.
BNZ says the RBNZ is focused on medium term inflation.
It says the central bank accepts there will be a near (how could it not?) but will only raise (or lower) rates based on how permanent that inflation shock becomes. And it will take time to establish a strong view on this, perhaps many months.
In the BNZ’s opinion this rules out any move in rates in April or the provision of any clarity as to when the RBNZ might start moving rates.
The possible exception to this is if New Zealand’s diesel supply deteriorates and the RBNZ goes into panic mode.
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