Reserve Bank's 'fine balance'

Should the Reserve Bank cut rates to boost inflation, or hike them to slow borrowing?

Friday, April 1st 2016, 1:56PM

by Susan Edmunds

Pity the Reserve Bank.

On one hand, it has households racking up more and more debt and migration pressures building on house prices.

On the other, tanking inflation expectations and actual inflation at record lows.

Should it cut to boost inflation, or hike to slow the borrowing?

Economists say it's a fine balance but more interest rate cuts are on the horizon.

Household claims, largely made up of mortgage borrowing, are rising at their fastest level since 2008. Before the GFC, household credit was 159% of household income. Now it is 162% and rising.

Reserve Bank data shows household claims were up a seasonally adjusted 0.6 per cent month-on-month in February, to a total $229.9 billion.

But at the same time, inflation expectations are falling, from predictions of 1.51 per cent one year out in December 2015 to 1.09 per cent in March this year.

Consumer inflation fell to a 16-year low of 0.1 percent in December.

Cameron Bagrie, ANZ’s chief economist, said it was a fine balance for the Reserve Bank to negotiate. “Inflation expectations are flagging, signalling that the Reserve Bank should cut the OCR even more to get inflation back up. But on the flip side there is credit growth.”

He said that indicated that people were borrowing to spend again.

“Is that the recipe for an economic accident two or three years down the track? The Reserve Bank is caught between opposing forces,” he said.

“To get inflation up they could cut the cash rate more but that could pour fuel on the housing fire and encourage people to get out and burn more money. It’s a delicate balancing act, where do you draw the line?”

But economist Shamubeel Eaqub said inflation was much more of a concern to the Reserve Bank because there was a risk that low inflation could become pervasive and hard to shake if they started to change price- and wage-setting decisions.

“They will cut again. Interest rates have to be lower. The dollar continues to appreciate and that is holding our rural and export sectors hostage.”

Nick Tuffley, of ASB, agreed more cuts were on the horizon. He expects the official cash rate to fall to 1.75%.

Eaqub said the Reserve Bank was struggling to adapt to a new environment where interest rates were likely to be low for a long time.

He said it was limited in what it could do with interest rate movements and needed to get better at using the other tool at its disposal: Signalling to the market.

“That’s the bit they have fluffed. You can see that because at the last monetary policy statement the governor said the market should have expected the cut because it had been well signalled. But no one did. The central bank doesn’t understand the importance of communication but it’s an important channel. Interest rates are already low so cutting rates is not going to do much. The tool it has left is its expectations through communication and they have to step up on that.”

Bagrie said the Reserve Bank was having to balance a number of balls in the air at one time, including the dairy sector, a shaky global outlook and booming migration putting more pressure on the housing market.

“To say it’s complicated and not clear cut at the moment is an understatement.”

Tags: interest rates