November 2018 Monetary Policy - Reserve Bank of New Zealand

 
Monetary
                                                                       Policy
                                                                       Statement
                                                                       November 2018

                                                                                       i
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Report and supporting notes published at:

     https://www.rbnz.govt.nz/monetary-policy/monetary-policy-statement

            Subscribe online: https://www.rbnz.govt.nz/email-updates

                         Copyright © 2018 Reserve Bank of New Zealand
     This report is published pursuant to section 165A of the Reserve Bank of New Zealand Act
                                                1989.
                                         ISSN 1770-4829

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                                                                                 RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Monetary Policy Statement
November 2018

Projections finalised on 31 October. Data finalised on 31 October.
Policy assessment finalised on 7 November.

Contents

Policy Targets Agreement                                               2    6. Statistical appendix                                     35

1. Policy assessment                                                   4
                                                                            		6.1 Key forecast variables                            36
2. Key policy judgements                                               5    		 6.2 Measures of inflation, inflation expectations,
                                                                            			    and asset prices                                 37
		 Box A: Recent monetary policy decisions                             13   		 6.3 Measures of labour market conditions             38
		 Box B: Petrol prices and monetary policy                            15   		 6.4 Composition of real GDP growth                   39
                                                                            		 6.5 Summary of economic projections                  40
3. Domestic activity and employment                                    17

		 Box C: Summary of recent business visits                            25

4. Prices and costs                                                    26

5. International and financial markets developments                    31

                                                                                                                                    1
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Policy Targets Agreement                                                    b)   The conduct of monetary policy will maintain a stable general
                                                                                 level of prices, and contribute to supporting maximum sustainable
                                                                                 employment within the economy.

Context

The Government’s economic objective is to improve the wellbeing and         2          Policy target
living standards of New Zealanders through a sustainable, productive
and inclusive economy. Our priority is to move towards a low carbon         a)   The price stability target will be defined in terms of the All Groups
economy, with a strong diversified export base, that delivers decent jobs        Consumers Price Index (CPI), as published by Statistics New
with higher wages and reduces inequality and poverty.                            Zealand.

Monetary policy plays an important role in supporting the Government’s      b)   For the purpose of this agreement, the policy target shall be to
economic objective. The Government expects monetary policy to be                 keep future annual CPI inflation between 1 and 3 percent over the
directed at achieving and maintaining stability in the general level of          medium-term, with a focus on keeping future inflation near the 2
prices over the medium term and supporting maximum sustainable                   percent mid-point.
employment.
                                                                            c)   The Bank will implement a flexible inflation targeting regime. In
This agreement between the Minister of Finance and the Governor of the           particular the Bank shall, in pursuing the policy target:
Reserve Bank of New Zealand (the Bank) is made under section 9 of the
Reserve Bank of New Zealand Act 1989 (the Act). The Minister and the             i.       have regard to the efficiency and soundness of the financial
Governor agree as follows:                                                                system;

                                                                                 ii.      seek to avoid unnecessary instability in output, employment,
                                                                                          interest rates, and the exchange rate; and
1         Monetary policy objective
                                                                                 iii.     respond to events whose impact on inflation is expected
a)       Under Section 8 of the Act the Reserve Bank is required to                       to be temporary in a manner consistent with meeting the
         conduct monetary policy with the goal of maintaining a stable                    medium-term target.
         general level of prices.

     2
                                                                                                     RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
3            Transparency and accountability                                        iii.   explain how current monetary policy decisions contribute
                                                                                           to supporting maximum levels of sustainable employment
a)      The Bank shall implement monetary policy in a transparent                          within the economy.
        manner. In addition to the requirements of section 15 of the Act the
        Bank shall in its Monetary Policy Statement (MPS):                     b)    The Bank shall be fully accountable for its judgements and actions
                                                                                     in implementing monetary policy.
       i.       explain what measures it has taken into account in respect
                of meeting the requirements of section 2(c) and explain
                how these matters have been taken into account in its
                implementation of monetary policy; and

       ii.      when inflation outcomes, and/or expected inflation
                outcomes, are outside of the target range explain the
                reasons for this; and

                                                                               Dated at Wellington this 26th day of March 2018

                                                                                                                                                      3
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Chapter 1
Policy assessment

Tena koutou katoa, welcome all.                                           As capacity pressures build, core consumer price inflation is expected to
                                                                          rise to around the mid-point of our target range at 2 percent.
The Official Cash Rate (OCR) remains at 1.75 percent. We expect to
keep the OCR at this level through 2019 and into 2020.                    Downside risks to the growth outlook remain. Weak business sentiment
                                                                          could weigh on growth for longer. Trade tensions remain in some major
There are both upside and downside risks to our growth and inflation      economies, raising the risk that trade barriers increase and undermine
projections. As always, the timing and direction of any future OCR move   global growth.
remains data dependent.
                                                                          Upside risks to the inflation outlook also exist. Higher fuel prices are
The pick-up in GDP growth in the June quarter was partly due to           boosting near-term headline inflation. We will look through this volatility
temporary factors, and business surveys continue to suggest growth will   as appropriate. Our projection assumes firms have limited pass through
be soft in the near term. Employment is around its maximum sustainable    of higher costs into generalised consumer prices, and that longer-term
level. However, core consumer price inflation remains below our 2         inflation expectations remain anchored at our target.
percent target mid-point, necessitating continued supportive monetary
policy.                                                                   We will keep the OCR at an expansionary level for a considerable period
                                                                          to contribute to maximising sustainable employment, and maintaining
GDP growth is expected to pick up over 2019. Monetary stimulus            low and stable inflation.
and population growth underpin household spending and business
investment. Government spending on infrastructure and housing             Meitaki, thanks.
also supports domestic demand. The level of the New Zealand dollar
exchange rate will support export earnings.

                                                                          Adrian Orr, Governor.

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                                                                                                  RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Chapter 2
Key policy judgements

• GDP growth is expected to be subdued in the near term, with businesses           Drivers of growth
  reporting that their activity has weakened. Growth is expected to pick up
  moderately over 2019, supported by fiscal stimulus and easier monetary           Conditions are in place for a sustained economic expansion. Fiscal
  conditions.                                                                      stimulus, monetary stimulus, and the lower exchange rate are all
                                                                                   supporting economic activity. Despite these drivers, business surveys
• Underlying inflation is slightly below 2 percent, but has been steadily          indicate that firms’ activity is expanding only slowly. Risks to global
  increasing. Firms’ input costs, such as fuel prices and wages, are               growth, such as international trade tensions, continue to increase.
  increasing. Consumer price inflation remains contained despite these
  higher costs. Inflation could rise excessively if firms rapidly pass on costs.   Government spending is supporting activity. The Families Package
                                                                                   increased household incomes from the start of the September quarter.
• Employment is near its maximum sustainable level. Higher GDP growth              Plans for spending and investment announced in Budget 2018 are
  is expected to drive employment slightly above this level. Increasing            expected to support growth. The KiwiBuild programme is assumed to add
  capacity pressure, supported by ongoing monetary stimulus, should                to the rate of house building from the second half of 2019.
  support the rise in underlying inflation towards the 2 percent target
  mid-point.                                                                       Net exports are increasing, partly as a result of the exchange rate
                                                                                   depreciation seen since mid-2017. As the composition of activity
• The outlook is subject to numerous uncertainties and judgements. Two             becomes less import-intensive, GDP growth is expected to increase.
  key assumptions are that firms continue to adjust prices only gradually          Although households’ purchasing power is lower as a result of the
  as costs increase and that weak business sentiment does not signal a             lower exchange rate, this is more than offset by slower growth in import
  lasting downturn in demand.                                                      volumes.

                                                                                                                                                             5
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Stimulatory monetary policy is expected to support growth and                                              Figure 2.1
employment, contributing to an increase in the use of resources to the                                     Output gap
point where capacity pressure develops (figure 2.1). Rising capacity                               (share of potential output)
pressure will help to lift underlying inflation, ensuring that it returns        3
                                                                                     %                                                                %
                                                                                                                                                          3
sustainably to the 2 percent target mid-point.                                                                                           Projection
                                                                                 2                                                                        2

Despite the fiscal and monetary stimulus underpinning growth, surveyed           1                                                                        1

business activity is currently weak. Businesses’ employment and                  0                                                                        0

investment intentions have declined in recent quarters. This evidence           -1                                                                        -1
suggests that demand has slowed, and hence quarterly GDP growth is
                                                                                -2                                                                        -2
expected to remain subdued in the near term (figure 2.2).
                                                                                -3                                                                        -3

The GDP growth outlook assumes that weak business sentiment                     -4                                                                        -4
                                                                                     2002   2005      2008     2011     2014      2017      2020
does not have a lasting negative effect on growth. However, if firms’
                                                                                                       Source: RBNZ estimates.
actual investment and hiring declines as a result of weak sentiment or
compressed profit margins, growth could be weaker than projected.
                                                                                                             Figure 2.2
The world outlook poses downside risks to domestic growth. Financial                                        GDP growth
conditions have tightened in some Asian economies, and economic                                                 (s.a.)
growth in China has slowed. Ongoing trade tensions remain a source of                %                                                             %
                                                                                7                                                                      7
uncertainty. These factors have contributed to volatility in international      6
                                                                                                                                         Projection
                                                                                                                                                       6
financial markets. Higher volatility has not yet affected our central outlook   5                                                                      5
for the New Zealand economy. We will continue to closely monitor the            4                                  Annual                              4

risks arising from the international economy.                                   3                                                                      3
                                                                                2                                                                      2

Inflation developments                                                          1                                                                      1
                                                                                0                                                                      0
                                                                                                                            Quarterly
                                                                                -1                                                                     -1
Inflation is increasing from its previous low levels. Fuel price rises over     -2                                                                     -2
the past year have increased the cost of living and placed pressure on          -3                                                                     -3
                                                                                     2002   2005     2008     2011      2014      2017      2020
household budgets. The increase in fuel prices in the September quarter
                                                                                                    Source: Stats NZ, RBNZ estimates.
saw annual headline CPI inflation rise to 1.9 percent. Measures of core
inflation, which remove the effects of volatile items such as fuel, have

  6
                                                                                               RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
moved higher, but generally remain slightly below the 2 percent target                                                         Figure 2.3
mid-point.                                                                                                                    CPI inflation
                                                                                                                                (annual)
Once the direct effect of higher fuel prices has passed, headline inflation                        %                                                                     %
                                                                                               6                                                                             6
is projected to drop temporarily below 2 percent (see box B). Over the                                                                                          Projection

medium term, rising capacity pressure is expected to lift inflation to                         5                                                                             5

around 2 percent (figure 2.3).                                                                 4
                                                                                                       Headline inflation
                                                                                                                                                                             4

Input cost pressures for firms are building. Fuel prices have increased                        3                                                                             3

significantly, largely reflecting increases in international oil prices. Recent                2                                        Core inflation                       2
pay equity settlements and minimum wage increases have led to higher
labour costs. In addition, the depreciation in the exchange rate has                           1                                                                             1

increased the cost of imported inputs.                                                         0                                                                             0
                                                                                                2002         2005      2008      2011       2014         2017     2020
                                                                                                                    Source: Stats NZ, RBNZ estimates.
So far, these cost pressures have largely been absorbed in lower profit                                  Note: Core inflation is the sectoral factor model measure.
margins. The relatively slow pass-through of input costs into overall
consumer prices is assumed to continue, in line with the experiences
reported by businesses in recent business visits (see box C in chapter 3).        Headline inflation over the past six years has been subdued, consistent
                                                                                  with firms being influenced by past low inflation when setting prices.
Aside from fuel, imported inflation is below average, as global inflationary      This persistently low inflation could also be a result of other unmeasured
pressure continues to pick up only gradually. Low import prices were a            shifts in the economy, such as high competitive pressure, technological
key factor keeping inflation low between 2012 and 2016.                           improvements, or increasing labour market flexibility. Regardless of the
                                                                                  underlying cause, inflation has been slow to increase, even as costs
Tradables inflation is expected to decline over the next year as the effect       have risen and the profit margins of firms have been compressed.
of the recent rise in fuel prices dissipates. This projection is based on the
assumption that world oil prices decline slightly from their current level.       We assume that this backward-looking pricing behaviour will persist, and
Over the medium term, tradables inflation is expected to settle slightly          as a result, underlying inflation will increase only gradually. However, if
below average as imported inflation remains modest, while increasing              firms start passing through cost increases more quickly, headline inflation
capacity pressure drives a rise in non-tradables inflation.                       could increase more rapidly than projected.

                                                                                                                                                                                 7
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Employment developments                                                                               Figure 2.4
                                                                              Population, employment, and labour force participation
We estimate employment to be near its maximum sustainable level (see             (rates as a share of working-age population, s.a.)
chapter 3). Increasing labour supply has been absorbed by the labour            73
                                                                                     %                                                              Millions
                                                                                                                                                          4.9
market, lifting employment growth. However, firms report some difficulty                                                                     Projection

in finding the type of labour they need.                                        70                               Participation rate
                                                                                                                                                          4.5

                                                                                67
Households are supplying labour at an unprecedented rate. The size of                                                                                     4.1

the population, labour force participation, and the employment rate have        64
                                                                                                               Employment rate                            3.7
all increased significantly since 2012 (figure 2.4).                            61
                                                                                              Working-age
                                                                                            population (RHS)
                                                                                                                                                          3.3
                                                                                58
The increased supply of labour has been quickly absorbed, leading to
declines in the unemployment rate (figure 2.5). The unemployment rate           55                                                                        2.9
                                                                                  2002         2005       2008       2011      2014   2017      2020
is projected to remain low as economic growth lifts employment above its
                                                                                                        Source: Stats NZ, RBNZ estimates.
maximum sustainable level, helping to drive underlying inflation towards
2 percent over the medium term.
                                                                                                              Figure 2.5
Despite the high level of labour supply, firms report increasing difficulty                               Unemployment rate
in finding labour. This suggests that there might be some divergence                                             (s.a.)
between the type of labour households are supplying and the type that          7.0
                                                                                     %                                                                 %
                                                                                                                                                           7.0
employers are looking for. There could be a number of possible causes                                                                        Projection
                                                                               6.5                                                                         6.5
for such a divergence, such as reluctance of workers to leave their
                                                                               6.0                                                                         6.0
current jobs, regional disparities in job opportunities, a lag between
                                                                               5.5                                                                         5.5
employers’ needs and workers’ training choices, or insufficient wage
incentives for workers to upskill or move locations.                           5.0                                                                         5.0

                                                                               4.5                                                                         4.5

Overall, indicators of labour market tightness suggest that employment         4.0                                                                         4.0

is near its maximum sustainable level. Further increases in employment         3.5                                                                         3.5

growth would likely depend on firms raising wages faster to attract            3.0                                                                         3.0
                                                                                     2002      2005       2008       2011      2014   2017      2020
suitable workers, which would place upward pressure on inflation. A
                                                                                                      Source: Stats NZ, RBNZ estimates.
structural (sustainable) improvement in employment would require non-

  8
                                                                                                   RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
monetary approaches to improve the alignment of labour supply and
                                                                                                               Figure 2.6
demand (for example, through education and training programmes).                                           Official Cash Rate

Monetary policy                                                                               %                                                       %
                                                                                          9                                                               9
                                                                                                                                             Projection
                                                                                          8                                                               8
The Policy Targets Agreement (PTA) specifies that the objectives for
monetary policy are to keep future annual CPI inflation between 1 and 3                   7                                                               7

percent over the medium term, and to contribute to supporting maximum                     6                                                               6

sustainable employment. In addition, the Bank is directed to avoid                        5                                                               5

unnecessary instability in output, employment, the exchange rate, and                     4                                                               4

interest rates, and to have regard to the efficiency and soundness of the                 3                                                               3
                                                                                                                                             Nov MPS
financial system.                                                                         2                                                               2
                                                                                                                                             Aug MPS
                                                                                          1                                                               1
The labour market has tightened and core inflation has increased from                      2002   2005   2008    2011      2014       2017     2020

                                                                                                            Source: RBNZ estimates.
its previous low level. However, GDP growth is expected to stay subdued
in the near term. Past low inflation outturns are assumed to continue
weighing on inflation. At the same time, cost pressures are increasing       Scenario 1: Inflation increases faster due to faster cost pass-through
largely as expected, although recent increases in fuel prices have
temporarily lifted CPI inflation. Stimulatory monetary policy remains        More rapid pass-through from recent cost increases could result in
necessary to ensure inflation continues to rise towards the target mid-      higher inflation. In our central projection, firms are assumed to continue
point over the medium term (figure 2.6). There are risks on both sides of    adjusting prices only gradually in response to increasing costs. However,
the policy outlook.                                                          firms report that these higher costs are squeezing margins. There is a
                                                                             risk that firms could raise prices faster than we assume in response to
Scenarios                                                                    these cost pressures.

While the outlook for the OCR has changed little over the past year          In this scenario, annual non-tradables inflation initially rises by around 0.5
(see box A), recent developments suggest two possible scenarios that         percentage points more over 2019 than in the central projection (figure
could shift the outlook for monetary policy. The first scenario shows how    2.7). The OCR begins to rise in the second half of 2019 in response to
monetary policy would respond if inflation increased faster than projected   stronger inflationary pressure (figure 2.9). CPI inflation is higher until
due to faster pass-through of costs to prices. The second scenario shows     the end of 2021. Stronger inflationary pressure means that a period
the response if GDP growth remained low due to a sustained demand            of sustained positive capacity pressure is no longer necessary for
slowdown.                                                                    underlying inflation to settle near 2 percent. As a result, there is less need

                                                                                                                                                              9
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Figure 2.7                                                                                                     Figure 2.8
                                      Non-tradables inflation                                                                                             GDP growth
                                             (annual)                                                                                                       (annual)
                      %                                                                   %                                       %                                                                %
                  6                                                                           6                               7                                                                        7
                                                                               Projection                                                                                               Projection
                                                                                                                              6                                                                        6
                  5                                                                           5                               5                                                                        5
                                                                                Inflation                                     4                                                          Central       4
                                                                               increases
                  4                                                              faster
                                                                                          4                                   3                                                                        3
                                                                                                                              2                                                           Softer  2
                                                                                                                                                                                         growth
                  3                                                                           3                               1                                                         continues 1

                                                                                                                              0                                                                        0
                                                                                Central
                  2                                                                           2                              -1                                                                        -1
                                                                                                                             -2                                                                        -2
                  1                                                                           1                              -3                                                                        -3
                   2002       2005       2008      2011      2014      2017       2020                                            2002   2005      2008      2011      2014      2017      2020
                                       Source: Stats NZ, RBNZ estimates.                                                                          Source: Stats NZ, RBNZ estimates.
      Note: The scenario shows the complete response of non-tradables inflation, including the effect of the           Note: The scenario shows the complete response of GDP growth, including the effect of the
                                   subsequent reaction of monetary policy.                                                                     subsequent reaction of monetary policy.

for monetary stimulus. By late 2020, the OCR is around 70 basis points                                         In this scenario, a demand slowdown sees annual GDP growth stay
higher than in the central projection, and inflation converges back to                                         below 3 percent over 2019 (figure 2.8). Softer GDP growth results in
around 2 percent.                                                                                              employment falling relative to its maximum sustainable level and the
                                                                                                               unemployment rate increasing. As it becomes clear that growth is not
Scenario 2: Softer growth continues                                                                            increasing as expected, the OCR would need to be reduced by about 75
                                                                                                               basis points below the central projection (figure 2.9). Weaker capacity
Fewer businesses have reported an increase in activity over the past                                           pressure in the scenario sees inflation increase more gradually. By 2020,
year, despite improving global conditions, strong population growth,                                           the monetary policy response starts to boost growth, raising employment
and low interest rates. This reported slowdown in activity is expected to                                      to around its maximum sustainable level and CPI inflation to 2 percent.
appear in GDP growth in the near term, with growth temporarily subdued
in our central projection. However, if deteriorating business sentiment
signals a lasting decline in domestic demand, GDP growth may remain
weak for longer than expected.

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                                                                                                                                             RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Figure 2.9
                                     Official Cash Rate

                     %                                                            %
                 9                                                                    9
                                                                        Projection
                 8                                                                    8

                 7                                                                    7

                 6                                                                    6

                 5                                                                    5
                                                                      Inflation
                 4                                                              4
                                                                     increases
                                                             Central   faster
                 3                                                              3

                 2                                                                    2
                                                       Softer growth
                 1                                      continues                     1

                 0                                                                    0
                  2002     2005     2008    2011      2014       2017      2020

                                       Source: RBNZ estimates.

                                                                                          11
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Table 2.1

Key judgements and risks

    Overarching narrative               Key judgements                                                                                                                      Risk to OCR1
    Robust global growth                 GDP growth in our major trading partners averages around 3.5% over the projection. Trade restrictions have a
                                                                                                                                                                                    
    continues                            limited impact on the global growth outlook, but there are risks of a more adverse scenario.
                                        Central banks continue to withdraw monetary stimulus, leading overseas interest rates to increase relative to New
                                                                                                                                                                                    
                                        Zealand. The New Zealand dollar TWI remains around 72 over the projection, with risks to the downside.
    Global inflationary pressure        Inflationary pressure in our major trading partners edges up only gradually.                                                                
    rises gradually                     Import price inflation in world terms is slightly below its post-2000 average over the projection.                                         
                                        Dubai oil prices fall from around USD 80 per barrel to USD 70 per barrel.                                                                  
                                        Whole milk powder prices stay around USD 3000 per metric tonne.                                                                            
    New Zealand GDP growth              GDP growth exceeds potential growth as temporary softness unwinds over 2019. Low business confidence does
                                                                                                                                                                                    
    rises above trend, as fiscal        not translate to persistently lower growth.
    and monetary stimulus               Annual house price inflation subsides from around 5% in 2018 to around 2% from 2020.                                                       
    support demand
                                        Household consumption growth slows as house price inflation slows and net immigration declines.                                            
                                        Annual net immigration falls from 50,000 in 2018 to 30,000 in 2020, reducing aggregate demand.                                             
                                        Export volumes grow in line with potential, while import volume growth declines due to the depreciation of the
                                                                                                                                                                                    
                                        exchange rate seen since mid-2017.
                                        KiwiBuild adds to residential investment gradually from mid-2019. Government spending and increased transfers
                                                                                                                                                                                   
                                        to households support GDP growth from the second half of 2018.
    With little slack left, capacity    Employment is around its maximum sustainable level and the output gap is close to zero.                                                    
    pressure builds as demand
                                        Labour force participation remains around 71% of the working age population.                                                               
    growth outstrips supply
                                         Unemployment rate falls to 4.2% and the output gap to reach 0.6% of potential output by 2021.                                              
    Inflation rises gradually to        Non-tradables inflation increases gradually, as capacity pressure increases and the dampening effect of past low
                                                                                                                                                                                    
    the 2 percent target                inflation gradually fades.
    mid-point
                                        Tradables inflation increases, but remains subdued.                                                                                         

                                        Pass-through of higher petrol prices into other consumer prices is limited.                                                                 
                                        Wage inflation rises from around 2% in 2018 to over 2.5% by 2021. Minimum wage changes are mostly absorbed
                                                                                                                                                                                    
                                        in firms’ margins and have a small impact on CPI inflation.
1
    Risk indicators refer to balance of risks to the OCR from each of the individual key judgements.  Balanced risks |  Upside risks |  Downside risks

    12
                                                                                                                           RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Box A                                                                                                         Figure A.1
                                                                                                          Official Cash Rate
Recent monetary policy decisions
                                                                                              %                                                        %
                                                                                          9                                                                9
Monetary policy decisions since 2016
                                                                                          8                                                                8

                                                                                          7                                                                7
The Bank has held the OCR at 1.75 percent since late 2016, with
the view that monetary policy would remain accommodative for a                            6                                                                6

considerable period. Through 2017 and the first half of 2018, the                         5                                                                5

projected path for the OCR was broadly flat and stable. There was no                      4                                                                4

clear reason to deviate from this stimulatory monetary policy stance, as                  3                                              May MPS           3
                                                                                                                                       Feb MPS
the impacts of economic developments on the OCR were offsetting.                          2                          Actual                                2
                                                                                                                                             Aug MPS
                                                                                          1                                                                1
                                                                                           2002   2005   2008    2011     2014        2017     2020
GDP growth declined from mid-2016 to early 2018, in part because of
                                                                                                            Source: RBNZ estimates.
lower house price inflation and less growth in residential construction. As
a result, the output gap did not increase as expected. Core inflation and
wage inflation remained low.
                                                                              Just before the May 2018 Statement, the objectives for monetary policy
Although GDP growth was lower than expected, labour market conditions         were adjusted to include keeping future annual CPI inflation between
appeared to tighten. The unemployment rate declined between 2016              1 and 3 percent over the medium term and contributing to supporting
and 2018, and business surveys indicated that firms found it increasingly     maximum sustainable employment. In the next two Statements,
difficult to find labour. At the same time, the outlook for growth was        employment was thought to be near its maximum sustainable level,
supported by fiscal stimulus and improving global conditions.                 but inflation remained low. The Bank’s judgement was that monetary
                                                                              policy needed to remain stimulatory to ensure inflation would continue to
In the May 2018 Statement, the Bank noted that the next OCR move              increase towards the target mid-point.
could be up or down. By the August 2018 Statement, downside risks
to the growth outlook were becoming apparent. The Bank reduced the            Monetary policy decisions 2013-2016
slope of the OCR path to signal the need for more prolonged monetary
stimulus (figure A.1).                                                        Under the current Reserve Bank Act (1989), monetary policy decisions
                                                                              are made by the Governor as single decision maker. It is a long-standing
                                                                              practice for this formal decision to be supported by advice from senior

                                                                                                                                                               13
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
policy experts. Figure A.2 provides the distribution of OCR advice for                                     Figure A.2
decisions between 2013 and 2016. It shows the balance of internal                              Distribution of internal OCR advice
advice through the tightening cycle in 2014 and the loosening cycle in
2015-2016. Figure A.3 shows the corresponding actual OCR moves at                  Number                                                               Number
                                                                                   15                                                                        15
each decision.
                                                                                   12                        Hike      Hold             Cut                  12
Generally, there was a clear majority in the balance of advice. Should the
current Reserve Bank Amendment Bill become law, our intention would                 9                                                                        9

be to publish the formal votes of the Monetary Policy Committee each
time a vote is taken. It is envisaged that a vote would not be called for           6                                                                        6

every meeting, but only when needed.
                                                                                    3                                                                        3

                                                                                    0                                                                        0
                                                                                             2013             2014             2015              2016

                                                                                                                    Source: RBNZ.

                                                                                                                Figure A.3
                                                                                                            Official Cash Rate

                                                                                        %                                                                %
                                                                                  4.0                                                                        4.0

                                                                                  3.5                                                                        3.5

                                                                                  3.0                                                                        3.0

                                                                                  2.5                                                                        2.5

                                                                                  2.0                                                                        2.0

                                                                                  1.5                                                                        1.5
                                                                                             2013             2014             2015              2016

                                                                                                                    Source: RBNZ.
                                                                             Note: The level of the OCR is shown as at each decision. There were eight decisions per year
                                                                                             from 2000 to 2015, and seven decisions per year since 2016.

 14
                                                                                                    RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Box B                                                                                    The PTA directs the Bank to ‘respond to events whose impact on inflation
                                                                                         is expected to be temporary in a manner consistent with meeting the
Recent petrol price increases and monetary policy                                        medium-term target’. As a result of this medium-term focus, the initial
                                                                                         effects of higher petrol prices on headline inflation do not require a
Petrol price inflation was the main contributor to the recent lift in headline           monetary policy response. However, petrol prices can have a lasting
inflation. Global oil prices have increased over the past year, and the New              effect on the economy through other channels, which may be important
Zealand dollar has depreciated. Annual headline inflation is projected                   for monetary policy.1 There are three channels through which petrol
to increase to slightly above 2 percent over the next six months, before                 prices affect overall inflationary pressure:
dipping below 2 percent as the effect of higher fuel prices drops out
in mid-2019. Announced national fuel excise tax increases will add to                    •     First-round effects – A one-off shift in the price of petrol has only
fuel price inflation for three years from the December 2018 quarter, but                       a transitory direct effect on inflation. Therefore, monetary policy
the contribution to CPI inflation will be small. Looking beyond short-                         ‘looks through’ these first-round effects.
lived volatility, fuel prices are expected to have only a limited effect on
underlying inflationary pressure.                                                        •     Second-round effects – The indirect effect of higher petrol prices
                                                                                               on other goods and services in the economy. For example,
                                          Figure B.1                                           higher petrol prices affect transport costs, which could raise the
                                   Regular petrol retail price                                 prices of a broader range of goods. Although these effects are
                                                                                               more widespread, the Bank would continue to look through such
                 $/litre
               2.6
                                                                               $/litre
                                                                                   2.6         developments to the extent that they are temporary. However,
               2.4                                                                 2.4
                                                                                               a higher-inflation environment may affect price- and wage-
                                                                                               setting behaviour. If changes in behaviour are long-lasting, then
               2.2                                                                 2.2
                                                                                               monetary policy will need to respond to offset higher medium-term
               2.0                                                                 2.0
                                                                                               inflationary pressure.
               1.8                                                                 1.8

               1.6                                                                 1.6
                                                                                         •     Third-round effects – Higher petrol prices mean that households
               1.4                                                                 1.4         have less disposable income to spend on other goods and
               1.2                                                                 1.2         services, dampening consumption and domestic demand. The
               1.0                                                                 1.0         increase in petrol prices over the past year suggests a reduction in
                           2005   2007   2009     2011    2013   2015   2017
                                                Source: MBIE.

                                                                                         1    See Delbruck, F., (2005) ‘Oil prices and the New Zealand economy’, Reserve Bank of New Zealand
                                                                                              Bulletin, Vol. 68, No. 4, December.

                                                                                                                                                                                               15
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
average annual household disposable income of about $400.2 To
         the extent that lower domestic demand feeds through into reduced
         capacity pressure, monetary policy may need to become more
         stimulatory to support employment and medium-term inflation.

The Bank looks through first-round effects, but the net effect on medium-
term inflationary pressures from second- and third-round effects is
uncertain. The Bank will continually assess its judgements in this area.

The Bank will continue to monitor:

1.       inflation expectations and pricing behaviour, for signs that higher
         fuel prices are affecting firms’ behaviour in a persistent manner;
         and

2.       household demand, for any sign that higher petrol prices are
         dampening consumer spending by more than expected.

2        Based on the latest Household Economic Survey data (2017) on household spending patterns and
         petrol consumption.

    16
                                                                                                        RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Chapter 3
Domestic activity and employment

• GDP growth has slowed since its most recent peak in 2016, although      Domestic activity
  some temporary factors lifted growth in the June 2018 quarter. At
  present, surveyed measures of firms’ activity are weak.                 GDP growth has slowed since its most recent peak in 2016. Annual GDP
                                                                          growth in the June 2018 quarter was 2.8 percent, slightly lower than our
• The labour market has tightened since 2016, despite the slowdown        estimate of the economy’s potential growth rate.
  in growth. A range of indicators show that employment is near its
  maximum sustainable level and the output gap is close to zero.          Following a few quarters of low growth, production GDP increased by
                                                                          1.0 percent in the June 2018 quarter (figure 3.1). This was stronger than
• Fiscal and monetary stimulus, and higher net exports are projected to   expected in the August Statement. This uptick has been mainly driven
  support growth and increase capacity pressure over the medium term.     by temporary factors, such as strength in services, utilities and primary
                                                                          production.

                                                                          The slowdown in growth since 2016 has coincided with moderating
                                                                          growth in household spending and falling measures of surveyed business
                                                                          activity. Growth in household consumption has dropped considerably
                                                                          from its 2016 peak, in line with declining house price inflation
                                                                          (figures 3.2 and 3.3). Residential investment contributed strongly to
                                                                          growth for several years and remains at a high level. However, residential
                                                                          investment has eased slightly as a share of potential output since 2016
                                                                          (figure 3.4).

                                                                                                                                                17
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Figure 3.1                                                                        Figure 3.2
                                  GDP growth                                                                    Consumption growth
                                      (s.a.)                                                                            (s.a.)
           %                                                                %                  %                                                                %
      8                                                                         8          8                                                                        8
                                                                  Projection                                                                          Projection
                                                                                           6                                                                        6
      6                                                                         6
                                                                                                                                Annual
                                                                   Annual                  4                                                                        4
      4                                                           Aug MPS 4

                                                                                           2                                                                        2
                                                                   Annual
      2                                                                   2
                                                                  Nov MPS
                                                                                           0                                                                        0
                                                                                                                                         Quarterly
      0                                                                         0
                                                     Quarterly                            -2                                                                        -2

      -2                                                                        -2        -4                                                                        -4

      -4                                                                        -4        -6                                                                        -6
           2002   2005     2008      2011      2014        2017      2020                      2002   2005       2008      2011      2014      2017      2020

                         Source: Stats NZ, RBNZ estimates.                                                   Source: Stats NZ, RBNZ estimates.
                                                                                      Note: The dashed line represents the average realised rate of growth since 2000.

                               Figure 3.3
                           House price inflation                                                                    Figure 3.4
                                  (s.a.)                                                                    Residential investment
           %                                                                %                            (share of potential output, s.a.)
     25                                                                         25
                                                                  Projection                   %                                                                %
                                                                                           8                                                                        8
     20                                                                         20                                                                    Projection

     15                                                                         15
                                                                                                                                                      Aug MPS
                                            Annual                                         7                                                                        7
     10                                                                         10

                                                                                                                                                      Nov MPS
      5                                                                         5
                                                                                           6                                                                        6

      0                                                                         0
                                             Quarterly

      -5                                                                        -5         5                                                                        5

     -10                                                                        -10
           2002   2005     2008      2011      2014        2017      2020
                                                                                           4                                                                        4
                   Source: CoreLogic, RBNZ estimates.                                       2002      2005       2008      2011      2014      2017      2020

                                                                                                              Source: StatsNZ, RBNZ estimates.

18
                                                                                                          RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
We estimate quarterly GDP growth to be modest over the second half                                              Figure 3.5
of 2018. Near-term growth is expected to be supported by household                               Domestic trading activity and GDP growth
consumption, which is boosted over the next few quarters by higher                                                 (s.a.)
labour incomes, the Government’s Families Package, and population                        8
                                                                                             %                                                                Net %
                                                                                                                                                                    60
growth. However, households’ disposable incomes are being squeezed
by higher petrol prices, which we expect to weigh on consumer spending.                  6                                                                          40
                                                                                                                   Domestic trading activity
Measures of firms’ activity from the Quarterly Survey of Business Opinion                4
                                                                                                                    past 3 months (RHS)
                                                                                                                                                                    20
(QSBO) point to weak domestic demand weighing on GDP growth in
the near term (figure 3.5). Business investment growth is also expected                  2                                                                          0

to decline over the near term, consistent with the sharp fall in firms’                  0
                                                                                                                                  Annual GDP growth
                                                                                                                                                                    -20
surveyed investment intentions.
                                                                                        -2                                                                          -40

Over the medium term, GDP growth is expected to increase.                               -4                                                                          -60
                                                                                             2002      2005        2008          2011       2014         2017
Government spending, stimulatory monetary policy, and higher net                                     Source: Stats NZ, NZIER, RBNZ estimates.
exports all contribute to the expected rise in activity. However, risks to the   Note: Domestic trading activity measures the net percentage of firms that reported an
medium-term growth outlook are to the downside.                                                    increase in activity over the past three months.

Government spending supports growth over the projection. The                                                      Figure 3.6
Government’s KiwiBuild programme is expected to contribute to                                            Import and export volumes
residential investment over the second half of the projection. Residential                             (share of potential output, s.a.)
construction activity may be weaker than projected, with risks on both                       %                                                                  %
                                                                                        40                                                                          40
the supply side (binding capacity constraints) and the demand side (low                                                                               Projection

house price inflation could reduce the incentive to build).
                                                                                        35                                          Imports                         35

Accommodative monetary policy has contributed to easier financial
conditions, seen in lower fixed mortgage rates and a lower exchange rate                30                                                                          30

(see chapter 5). The lower exchange rate and ongoing growth in global
                                                                                                                                  Exports
demand are expected to support export volumes (figure 3.6).                             25                                                                          25

Over the next couple of years, slower growth in import volumes is                       20                                                                          20
                                                                                          2002       2005      2008       2011     2014        2017      2020
the main driver of higher net exports. The weaker exchange rate and
                                                                                                         Source: Stats NZ, RBNZ estimates.
hence higher import prices are expected to drive a substitution towards

                                                                                                                                                                          19
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Figure 3.7                                     Growth in business investment is expected to recover over the medium
                                      Output gap                                     term in response to increasing capacity pressure (figure 3.8). Over
                              (share of potential output)                            the projection, higher GDP growth and increasing labour costs should
            3
                %                                                           %
                                                                                3
                                                                                     encourage firms to invest in capital. Recent business visits indicated that
                                                                  Projection
                                                                                     firms plan to invest in physical capital and automation in response to
            2                                                                   2
                                                                                     difficulty finding workers and increasing labour costs (box C).
            1                                                     Aug MPS 1

            0                                                                   0    Labour and capital constraints may be restricting firms’ ability to expand
           -1
                                                                  Nov MPS
                                                                                -1
                                                                                     production. It is possible that capacity pressure is stronger than we
                                                                                     currently estimate, given that there is always uncertainty around
           -2                                                                   -2
                                                                                     estimates of potential output. However, at present, the Bank’s indicators
           -3                                                                   -3   of capacity pressure suggest that the output gap is around zero.
           -4                                                                   -4
                2002   2005      2008    2011      2014    2017      2020
                                                                                                                        Figure 3.8
                                 Source: RBNZ estimates.
                                                                                                                Business investment growth
                                                                                                                          (annual)

domestic goods and services. In addition, the composition of GDP growth                          40
                                                                                                      %                                                            %
                                                                                                                                                                       40
is expected to become less import-intensive as growth in household                                                                                       Projection
                                                                                                 30                                                                    30
consumption and business investment slows.
                                                                                                 20                                                                    20

A key risk to the medium-term GDP growth outlook is that import volumes                          10                                                                    10

may be persistently higher than expected. There is also downside risk                             0                                                                    0
to the outlook for export volumes. Downside risks to global growth have
                                                                                                -10                                                                    -10
increased and prices for some of New Zealand’s key commodity exports
have softened recently.                                                                         -20                                                                    -20

                                                                                                -30                                                                    -30
                                                                                                      2002   2005    2008      2011     2014      2017      2020
Lower growth over the second half of 2018 is expected to keep the output
                                                                                                                    Source: Stats NZ, RBNZ estimates.
gap close to zero (figure 3.7). However, over the medium term, capacity
pressure is expected to build as GDP growth increases, driven by fiscal
and monetary stimulus and higher net exports.

 20
                                                                                                                RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Labour market                                                                                                                 Figure 3.10
                                                                                                             Permanent and long-term working-age migration
The labour market has tightened since 2016, despite softer GDP growth.                                                  (quarterly, annual total)
The unemployment rate has fallen during that time, to 4.5 percent in the                                  120
                                                                                                             000s                                                                   000s
                                                                                                                                                                                       70
June 2018 quarter.                                                                                                                                                        Projection
                                                                                                                                                                                       60
                                                                                                          110
                                                                                                                                                                                       50
                                                                                                          100
The share of the population participating in the labour force is near a                                                                          Arrivals                              40
                                                                                                            90
historical high. Since 2013, increases in participation, in addition to high                                                                                                           30
population growth, have contributed to rapid growth in the labour force                                     80
                                                                                                                          Net (RHS)                                                    20
(figure 3.9). The labour market has more than absorbed this increase                                        70
                                                                                                                                                                                       10
in supply, with employment growth outpacing labour force growth.                                            60
                                                                                                                                                                                       0
Employment is at its highest ever level relative to the working-age                                         50                                Departures                               -10
population.                                                                                                 40                                                                         -20
                                                                                                              2002       2005      2008      2011       2014      2017       2020
                                                                                                                                 Source: Stats NZ, RBNZ estimates.
                                         Figure 3.9
                            Labour force and population growth
                                          (annual)                                          The labour force participation rate is assumed to remain steady at around
                 7
                     %                                                             %
                                                                                       7
                                                                                            71 percent.1 This results in a high but stable share of the population being
                                                                         Projection         employed over the projection. While the labour force participation rate
                 6                                                                     6
                                                                                            is expected to remain at high levels, labour force growth is expected to
                 5                                                                     5
                                                         Labour                             decline over the medium term due to falling net immigration (figure 3.10).
                 4                                        force                        4

                 3                                                                     3
                                         Working-age
                                                                                            Over the next few years, employment is expected to grow faster than
                 2                        population                                   2
                                                                                            the labour force. The labour market is projected to tighten, with the
                 1                                                                     1    unemployment rate dropping further over 2019 and 2020 (figure 3.11).
                 0                                                                     0

                -1                                                                     -1   The risks to our labour market projection are balanced. On the
                     2002    2005     2008     2011      2014     2017      2020
                                    Source: Stats NZ, RBNZ estimates.
                                                                                            downside, the projected moderation in near-term GDP growth could
                                                                                            affect the labour market more than we have assumed, resulting in

                                                                                            1     See Callaghan, M., J. Culling and F. Robinson (forthcoming), ‘Ageing is a drag: projecting labour-force
                                                                                                  participation in New Zealand’, RBNZ Analytical Note.

                                                                                                                                                                                                      21
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Figure 3.11                                                                                Figure 3.12
                     Employment and unemployment rates                                                   Difficulty finding skilled and unskilled labour
                                   (s.a.)                                                                                      (s.a.)
                 %                                                           %                       Net %                                                                 Net %
            69                 Unemployment rate (RHS)                           7                  60                                                                         60
                                                                   Projection
                                                                                                    40                                               Skilled                   40
            67                                                                   6
                                                                                                    20                                                                         20

                                                                                                     0                                                                         0
            65                                                                   5
                                                                                                   -20                                          Unskilled                      -20

            63                                                                   4                 -40                                                                         -40
                                     Employment rate
                                   (share of working-age
                                        population)                                                -60                                                                         -60

            61                                                                   3                 -80                                                                         -80
              2002    2005      2008     2011      2014     2017      2020                               2002       2005        2008         2011        2014         2017
                             Source: Stats NZ, RBNZ estimates.                                                             Source: NZIER, RBNZ estimates.
                                                                                            Note: Difficulty finding labour measures the net percentage of firms that reported an increase in
                                                                                                        difficulty finding skilled and unskilled workers over the past three months.

lower employment growth and higher unemployment. Conversely, the
labour market could tighten faster if labour demand remains high and
labour force growth moderates. A tighter labour market could drive wage              Evidence reported by employers suggests the labour market is currently
inflation higher and push CPI inflation above the target mid-point.                  tight, and that employment is above its maximum sustainable level.
                                                                                     However, the picture is mixed. Some other measures of unemployment
Maximum sustainable employment                                                       and turnover suggest that some slack remains in the labour market. The
                                                                                     divergence of indicators may suggest that if workers’ skills and abilities
The Reserve Bank interprets maximum sustainable employment as the                    were better suited to employers’ needs, then employment could rise
highest utilisation of labour resources that can be maintained over time             higher and still be sustainable.
without generating an acceleration in inflation. A broad range of indicators
suggests that employment is near its maximum sustainable level (table                Firms appear to be struggling to fill vacancies at all skill levels. QSBO
3.1). Over the medium term, employment is expected to rise slightly                  measures of the difficulty of finding labour have risen (figure 3.12). During
above its maximum sustainable level, as stronger GDP growth boosts                   business visits, firms confirmed this story. Businesses across a broad
demand for labour.                                                                   range of industries said that they were having to lower their skill and
                                                                                     quality requirements and raise wages to fill positions.

 22
                                                                                                                     RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
In contrast, some other indicators of the labour market suggest that                            Figure 3.13
employment may still be below its maximum sustainable level. One                              Job-finding rate
                                                                                       (four-quarter moving average)
example is the job-finding rate, which is the proportion of unemployed
people in the previous quarter who transitioned to employment in the     70
                                                                              %                                                                %
                                                                                                                                                   70
current quarter. The data shows that the ease with which unemployed
people can find work has not recovered significantly since the Global    65                                                                        65

Financial Crisis (figure 3.13).
                                                                         60                                                                        60

                                                                         55                                                                        55

                                                                         50                                                                        50

                                                                         45                                                                        45
                                                                              2002     2005        2008         2011        2014        2017
                                                                                           Source: Stats NZ, RBNZ estimates.
                                                                         Note: The dashed line represents the average job-finding rate since 2000.

                                                                                                                                                        23
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Table 3.1

Summary of indicators of employment and maximum sustainable employment
Indicator type                    Employment below MSE                                                Employment at MSE                                                   Employment above MSE
Indicator suite                   Unemployment rate gap (reduced-form                                 Unemployment rate gap (structural model) Employment rate gap
                                  model)                                                                                                       (total employment)
                                  Employment rate gap (filled jobs)
Unemployment                      Youth unemployment rate (15-19 years)                               Range of NAIRU estimates
                                  Underemployment rate                                                Underutilisation rate
                                                                                                      Medium-term unemployment rate
                                                                                                      Maori and Pacific unemployment rate
                                                                                                      Youth unemployment rate (20-24 years)
Business                                                                                                                                                                  QSBO difficulty finding labour
surveys                                                                                                                                                                   QSBO labour as limiting factor
                                                                                                                                                                          QSBO overtime worked
Flows data                        Job-finding rate
                                  Job-to-job flows
Other                                                                                                                                                                     Job separation rate
                                                                                                                                                                          Vacancy rate
Note:   The job-finding rate is the proportion of unemployed people in the previous quarter who transitioned to employment in the current quarter. The job-separation rate is the proportion of employed people in the previous quarter who
        transitioned to unemployment in the current quarter. Job-to-job flows measures employed people who move from one job to another, without a period of unemployment. The vacancy rate is the number of vacancies divided by the
        number of unemployed people. NAIRU stands for Non-accelerating Inflation Rate of Unemployment. The vacancy rate is calculated by taking the number of vacancies divided by the sum of vacancies and employment.

  24
                                                                                                                                                             RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Box C                                                                          There was little sense among firms that capacity pressures had eased,
                                                                               despite the slower GDP growth over the past 18 months. This was
Summary of recent business visits                                              consistent with emerging cost pressure.

The Bank regularly meets with a range of organisations to improve our          Cost pressures are coming from a range of factors, including rising
industry knowledge and understanding of current economic conditions.           labour costs, rising materials costs, a lower exchange rate, increasing
In our most recent round of visits, we spoke with 41 businesses across         distribution costs, and increasing regulatory compliance costs.
Auckland, Hamilton, Rotorua, Wellington, Christchurch, and Dunedin.
                                                                               For many firms, cost increases were resulting in deteriorating margins,
We engaged with businesses from a range of industries to better                rather than increased prices. Firms said there were several reasons
understand demand and investment intentions in light of low reported           why they were absorbing cost increases, rather than passing them on to
business confidence. In addition, we looked to inform our assessment of        prices:
labour market conditions and to gauge cost pressure more broadly.
                                                                               •     perceived competition in their industry;
Most of the firms suggested that activity had remained robust over the
past year. Investment intentions were generally strong, despite some           •     limited pricing power for firms competing in global markets; and
uncertainty around government policy, with many firms noting that
increasing labour costs would encourage capital investment. This was in        •     fixed-price, long-term contracts, particularly in the construction
contrast to the weakness in activity and investment intentions reported              sector.
in business surveys. Firms were generally positive about growth going
forward. However, capacity constraints may limit further strong growth,
particularly in the construction industry.

Conversations with firms highlighted how difficult it is to find appropriate
labour. Many firms were experiencing shortages of both skilled and
unskilled labour. Employers were having to lower their skill and quality
requirements to fill jobs. Wage growth was similar to, or higher than,
previous years. Firms were concerned about further acceleration in
labour costs due to minimum wage increases, union negotiations, and
potential employment law changes.

                                                                                                                                                          25
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Chapter 4
Prices and costs

• CPI inflation has been temporarily boosted by higher fuel prices. Annual       Consumer price inflation
  CPI inflation increased to 1.9 percent in the September 2018 quarter,
  and is expected to temporarily rise above 2 percent in 2019.                   Annual CPI inflation increased to 1.9 percent in the September 2018
                                                                                 quarter (figure 4.1). CPI inflation has been temporarily boosted by higher
• Most measures of core inflation remain below 2 percent, but have               fuel prices, which are expected to raise CPI inflation until the second half
  increased over the past year. Firms are starting to raise prices at a faster   of 2019. From 2020 onwards, we expect that inflation will increase to
  rate as cost pressures increase.                                               around 2 percent as capacity pressure builds.

• Over the medium term, increasing capacity pressure is expected to lift         Most estimates of core (underlying) inflation remain below 2 percent, but
  underlying inflation to the 2 percent target mid-point.                        have been rising since the start of 2018 (figure 4.2).1 These estimates
                                                                                 filter out temporary volatility in price movements (such as recent sharp
                                                                                 rises in petrol prices) to estimate the underlying trend in inflation.Higher
                                                                                 core inflation signals an increase in domestic inflationary pressure.

                                                                                 Higher core inflation is consistent with the tightening in the labour market
                                                                                 observed over the past year. It is also consistent with our assumption that
                                                                                 the restraining effect of firms’ backward-looking price-setting behaviour
                                                                                 (where past sustained low headline inflation has dampened price setting)
                                                                                 will gradually diminish. Rising cost pressure has coincided with more

                                                                                 1     CPI inflation excluding food and energy remains low compared to other measures of core inflation. This
                                                                                       measure is expected to rebound in the coming year as the impact of fees-free tertiary education for first-
                                                                                       year students drops out of annual calculations.

  26
                                                                                                                  RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Figure 4.1                                                                   Figure 4.2
                                           CPI inflation                                                          Core inflation measures
                                             (annual)                                                             (annual, excluding GST)
                     %                                                          %
                                                                                                   %                                                                   %
                 6                                                                  6          5                                                                           5
                                                                       Projection

                 5                                                                  5                             Sectoral
                                                                                               4                   factor                                                  4
                                                                                                                   model        Factor
                 4                                                                  4                                           model
                                                                                               3                                                                           3
                                                                                                                                              Weighted
                 3                                                                  3
                                                                         Nov                                                                   median
                                                                         MPS
                                                                                               2                                                                           2
                 2                                                                  2
                                                                         Aug
                 1                                                       MPS        1          1                                                                           1
                                                                                                                                  Ex-food
                                                                                                                                                  Trimmed
                                                                                                                                 and energy
                                                                                                                                                 mean (30%)
                 0                                                                  0          0                                                                           0
                  2002     2005     2008      2011     2014     2017     2020                      2002      2005        2008        2011        2014           2017

                                   Source: Stats NZ, RBNZ estimates.                                                Source: Stats NZ, RBNZ estimates.

firms increasing prices in recent quarters according to the QSBO (figure                                                Figure 4.3
4.3).                                                                                                         Firms’ costs and selling prices
                                                                                                                           (s.a.)
                                                                                               Net %                                                               Net %
We project that annual CPI inflation will rise to 2 percent in the December                   70                                                                           70

2018 quarter, but drop back below 2 percent in 2019 when the recent                           60                                                                           60

increase in fuel prices drops out of the annual calculation. Annual CPI                       50                                                                           50

                                                                                              40                                                                           40
inflation returns to around 2 percent over 2020, supported by higher non-
                                                                                              30                                                        Costs              30
tradables inflation as capacity pressure gradually increases.
                                                                                              20                                                                           20

                                                                                              10                                                                           10
Surveyed inflation expectations remain consistent with medium-term
                                                                                               0                                                                           0
annual inflation of around 2 percent. Inflation expectations remain close                                                            Selling prices
                                                                                             -10                                                                           -10
to 2 percent across all horizons (figure 4.4).
                                                                                             -20                                                                           -20
                                                                                                   2002      2005        2008        2011        2014           2017
                                                                                                                             Source: NZIER.
                                                                                        Note: These measures show the net percentage of firms that reported an increase in costs or
                                                                                                               selling prices over the past three months.

                                                                                                                                                                                      27
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Figure 4.4                                                                                      Figure 4.5
                                   Inflation expectations                                                                             Tradables inflation
                                           (annual)                                                                                        (annual)
                   %                                                              %                                    %                                                             %
               5                                                                      5                            8                                                                     40
                                                                                                                                             Tradables                      Projection
                                                                                                                                              inflation
                                                                                                                   6                                                                     30
               4                                                                      4
                                                    1-year                                                                                                   Fuel price
                                                                                                                   4                                                                     20
                                                                                                                                                          inflation (RHS)
               3                                                                      3
                                                                                                                   2                                                                     10
                                                             2-year
                                                                      10-year
               2                                                                      2                            0                                                                     0

                                                                                                                  -2                                                                     -10
                                                                                                                                                 Tradables
               1                                                                      1                                                      inflation (ex-fuel)
                                                                                                                  -4                                                                     -20

               0                                                                      0                           -6                                                                     -30
                   2002     2005        2008       2011        2014        2017                                        2002   2005    2008     2011       2014      2017      2020
                                        Source: RBNZ estimates.
                                                                                                                                     Source: Stats NZ, RBNZ estimates.
       Note: Inflation expectation measures are estimates drawn at each time horizon from the RBNZ
        inflation expectations curve, based on surveys of businesses and professional forecasters.

Imported inflation and world prices                                                                  While fuel prices have increased, ex-fuel tradables inflation has been
                                                                                                     negative so far over 2018 and is projected to remain subdued in the
Tradables inflation has been higher since the start of 2017, following an                            near term. Below-average food price inflation and the lagged impact
extended period of falling prices (figure 4.5). Ongoing global growth has                            of the previously high New Zealand dollar continue to constrain ex-fuel
absorbed spare capacity worldwide. This has placed upward pressure                                   tradables inflation.
on imported inflation, which nonetheless remains low in absolute terms
(see chapter 5). A rise in oil prices has been an important driver of higher                         Over the medium term, the lagged impact of recent declines in the New
import prices over the past year (figure 4.6).                                                       Zealand dollar is also expected to support tradables inflation. Announced
                                                                                                     increases in national fuel excise duty are expected to lift fuel prices and
With global inflationary pressure rising, and some central banks reducing                            tradables inflation over the next three years. Tradables inflation settles
monetary stimulus, the New Zealand TWI has depreciated since the start                               at around 0.7 percent by the end of the projection, slightly below its
of 2017 (figure 4.7). This depreciation has raised import prices in New                              historical average.
Zealand dollar terms.
                                                                                                     One of the key risks to the outlook for tradables inflation is that if oil
                                                                                                     prices do not decline as assumed, fuel prices would contribute more

 28
                                                                                                                                RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Figure 4.6                                       to tradables inflation over the projection. The New Zealand dollar may
                                        Dubai oil prices                                   also continue to depreciate, increasing the cost of imports more than
                                             (s.a.)                                        expected.
               USD/barrel                                                    USD/barrel
               120                                                                   120

                                                                                           Domestic inflation and wages
                                                                        Projection

               100                                                                   100

                                                                        Nov MPS            Non-tradables inflation has remained relatively low by historical
                80                                                                   80
                                                                                           standards over recent years (figure 4.8). Low levels of non-tradables
                60                                                      Aug MPS 60         inflation have partially reflected firms’ subdued price-setting behaviour.
                                                                                           Firms appear to have been influenced by past low headline inflation
                40                                                                   40    when making pricing decisions in recent years. Domestically-generated
                                                                                           inflation has also been held down by the slow reduction in spare capacity
                20
                  2002      2005     2008     2011      2014     2017      2020
                                                                                     20    in the economy following the Global Financial Crisis.
                                   Source: Reuters, RBNZ estimates.

                                         Figure 4.7                                                                               Figure 4.8
                                   New Zealand dollar TWI                                                                   Non-tradables inflation
                                                                                                                                   (annual)
                                                                                                             %                                                               %
                 Index                                                         Index                     6                                                                       6
                85                                                                   85                                                                            Projection
                                                                        Projection
                80                                                                   80                  5                                                                       5
                                                                        Aug MPS
                75                                                                   75
                                                                                                         4                                                                       4
                70                                                      Nov MPS 70                                                                                    Nov
                                                                                                                                                                      MPS

                65                                                                   65                  3                                                                       3

                60                                                                   60                                                                               Aug
                                                                                                         2                                                            MPS        2
                55                                                                   55

                                                                                                         1                                                                       1
                50                                                                   50                   2002      2005      2008      2011      2014      2017      2020
                  2002      2005     2008     2011      2014     2017     2020
                                                                                                                             Source: Stats NZ, RBNZ estimates.
                                       Source: RBNZ estimates.
                                                                                                   Note: The dashed line represents the post-2000 average of realised annual non-tradables
                                                                                                                                          inflation.

                                                                                                                                                                                             29
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Figure 4.9                                           The dampening impact of the Government’s fees-free policy for first
                            Wage inflation and expectations                                 year tertiary students on non-tradables inflation will unwind in 2019.
                                        (annual)                                            This policy is estimated to have reduced non-tradables inflation by
           4.0
                 %                                                                %
                                                                                      4.0
                                                                                            approximately 0.3 percentage points over 2018.
                                                                         Projection

           3.5                                                                        3.5   Non-tradables inflation is expected to increase over the medium term
                                            Expected wage growth

           3.0                                                                        3.0
                                                                                            as capacity pressure in the economy builds. The dampening effect of
                                                                                            previous low inflation on price setting is also expected to continue to
           2.5                                                                        2.5
                                                                                            fade.
           2.0                                                                        2.0
                                                                                            The risks to the non-tradables inflation outlook are to the upside. Firms
           1.5                                Labour Cost Index                       1.5
                                                  (private)                                 may increase prices faster if domestic labour and import costs (including
           1.0                                                                        1.0   fuel) increase faster than anticipated, and margins erode further. In
                 2002     2005      2008      2011     2014       2017     2020
                     Source: Stats NZ, RBNZ survey of expectations, RBNZ estimates.
                                                                                            addition, firms may pass on wage increases to consumer prices to a
             Note: Dashed lines represent the 20-year average of respective data series.
                                                                                            greater extent than anticipated. Firms’ price-setting may also become
                                                                                            less influenced by the subdued levels of inflation seen over recent years.
                                                                                            Conversely, non-tradables inflation and capacity pressure might increase
Recently there have been some signs that upward pressure on non-                            more slowly than anticipated if downside risks to the growth outlook were
tradables inflation is beginning to build. Wage inflation has increased,                    to materialise.
boosted by factors such as the pay equity settlement and minimum wage
increase (figure 4.9). Wage expectations have also increased over recent
quarters, consistent with our assessment that employment is near its
maximum sustainable level (see chapter 3). Wage growth is expected
to increase as the labour market tightens and higher headline inflation
affects wage negotiations. Our forecasts also incorporate the minimum
wage increases announced by the Government.

Business surveys suggest that firms are looking to increase prices as
cost pressures intensify. However, in some instances firms’ input costs
are increasing faster than output prices, putting downward pressure on
margins.

 30
                                                                                                                   RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
Chapter 5
International and financial markets
developments

• Global growth remains strong, but is expected to slow over 2019.            Global growth remains strong
  Financial conditions have tightened in many countries, trade tariffs have
  been imposed, and political uncertainty remains high.                       Economic growth in 2018 has remained solid in many of New Zealand’s
                                                                              trading partners (figure 5.1). However, the solid average masks divergent
• Domestic financial conditions have eased over the past year, reflected in   growth outcomes in many economies. Growth in the United States
  lower wholesale and retail interest rates, and a depreciation in the New    has been strong, reflecting significant fiscal stimulus and buoyant
  Zealand dollar exchange rate.                                               consumer spending. Growth in Europe has weakened in recent quarters.
                                                                              However, growth is expected to moderate across many economies. The
• The balance of risks to the global economic outlook remains to the          International Monetary Fund (IMF) has lowered its projections for global
  downside.                                                                   growth as some key downside risks have started to crystallise, which
                                                                              aligns with our projections.

                                                                              Increasing inflationary pressure in some major economies has resulted
                                                                              in their central banks starting to tighten monetary policy. Unemployment
                                                                              rates have been falling significantly in many economies, and in some
                                                                              cases wage pressures are starting to emerge (figure 5.2).

                                                                              The outlook for growth in Asian economies has worsened in recent
                                                                              months. The removal of monetary stimulus by the Federal Reserve and
                                                                              the resulting appreciation of the US dollar have seen financial conditions

                                                                                                                                                     31
RESERVE BANK OF NEW ZEALAND/MONETARY POLICY STATEMENT, NOVEMBER 2018
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