The RBNZ’s Conway says inflation continues to ease in a weak economy

(Bloomberg) — New Zealand’s central bank said it expects inflation to continue to ease, but it needs more time to be sure.

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„Good progress has been made in bringing inflation back to the RBI’s 1-3% target band,” Chief Economist Paul Conway said in a speech in Wellington on Wednesday. Increasing spare capacity in the economy and falling inflation expectations are expected to further reduce price pressures while „sticky” domestic costs are also expected to eventually decline.

„These processes may happen faster or slower than currently planned,” he said. „Overall, a period of restrained policy is necessary to give us confidence that inflation will return to target within a reasonable timeframe.”

At its last policy meeting in May, the RBNZ predicted it would not start cutting its official cash rate from 5.5% until the third quarter of next year. Economists expect it to go ahead much sooner than that, with most opting for a move later this year and some predicting that easing will begin as early as 2025.

The economy has contracted in four of the previous five quarters and managed to break out of recession only in the first quarter of this year, when data is expected to grow by 0.1% when it is released tomorrow.

Conway said policymakers expect spare capacity to start emerging in the economy in 2024 and that will „strongly feed into domestically generated low inflation”, an expectation supported by recent RBNZ research.

A study found that the effect of capacity squeezes on inflation, captured by the Phillips curve, has been stronger in recent years, he said. This suggests that residual inflation may soon ease as spare capacity emerges in product and labor markets.

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„Second, we expect households and firms to increasingly build lower inflation expectations into their wage and price-setting decisions,” Conway said. „Since inflation expectations can be self-fulfilling, lower inflation expectations can help reduce inflationary persistence.”

’A Touch Tovish’

The RBNZ’s hawkish bias in recent months has been driven by concerns that domestic or non-traded inflation has been higher than expected.

Conway said the bank expects inflation to spread to non-traded items, where monetary policy typically takes longer to adjust, such as restaurant meals and ready-to-eat food.

„Inflation in this category of non-trade increased more slowly than the epidemic and has recently started to decline,” he said. „This decline will continue as the labor market continues to ease.”

The tone of Conway’s speech „felt like a hiccup compared to what it could have been,” said Doug Steele, senior economist at the Bank of New Zealand in Wellington. „We continue to see the first rate cut in February, but the latest incoming data suggests the risk of an early move has increased.”

Conway would not be drawn on whether the RBNZ had reassessed its assessment of risks or when interest rates could be expected to fall.

„I can’t give you a magic formula for when interest rates will come down,” he said. „We’re looking at everything to give us hope that inflation will be back in the band in a sustainable way, and we’re not there yet.”

(Updates with Economist’s opinion in paragraph 12)

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