Reserve Bank governor Graeme Wheeler has emphasised the flexibility written into his inflation policy targets agreement, which means he has to look beyond weak headline inflation in deciding whether to cut interest rates.
Wheeler singled out slower growth in China, which accounted for 40 percent of global growth in 2014, as the biggest risk to New Zealand and the global economy in a speech today to the Canterbury Employers' Chamber of Commerce, but he also cited supply-side shocks that are positive for local economic growth, including cheaper oil and strong inbound migration.
The speech comes after Wheeler last month opened to door for further cuts to the official cash rate, now at 2.5 percent, having indicated he was done with cutting the OCR in the December monetary policy statement.
Today he repeated that some further policy easing maybe needed over the coming year to nudge future average inflation back to the 2 percent mid-point of the PTA's target band. The proviso was that it could be needed "if concerns deepen around the prospects for the global economy and its impact on New Zealand."
Annual inflation is currently just 0.1 percent, reflecting negative inflation in the tradables sector, which had prompted some commentators to call for an immediate OCR cut.
"A mechanistic approach can lead to an inappropriate fixation on headline inflation," Wheeler said in his speech. "It would cut across the flexibility deliberately built into the PTA framework, and risk creating serious distortions in the financial system, housing market, and broader economy."
Flexibility in the PTA meant considering the impact of policy decisions on asset prices, financial stability and efficiency, volatility in output, interest rates and the exchange rate, he said.
The decline in tradables inflation was primarily driven by the 75 percent slump in crude oil prices but he said exceptional movements in commodities such as oil are recognised as factors that can temporarily have an impact on inflation, meaning they could be looked through.
"It would be inappropriate to attempt to offset the low oil price effect through the OCR, which tends to influence inflation outcomes over an 18 month to two-year horizon," he said.
China was a risk to the global economy because of its impact on global trade volumes and commodity prices, the rapid build-up of corporate indebtedness and the difficulty in switching that economy away from investment and manufacturing toward stronger private consumption and services.
While China's corporate indebtedness wasn't the highest among major economies, at 220 percent of gross domestic product, the extent of its debt accumulation to over 70 percent of GDP in six years was "unprecedented," Wheeler said.
For the domestic economy, El Nino was still a risk, although that may have been somewhat mitigated by recent rains and the trend toward more irrigation since the 1997 drought.
Weak dairy prices were another risk, with dairy farmers having endured two years of negative cash flows already, forcing them to cut back spending.
Whole milk powder slumped 10.4 percent to US$1,952 a tonne in the GlobalDairyTrade auction overnight, suggesting a slower return to the US$3,300/tonne by mid-2018 forecast in the December MPS.
There was uncertainty about the continued strong pace of net inbound migration, which creates demand pressures but also raises the economy's potential, Wheeler said.
Figures this week showed New Zealand had a record net gain in migrants of 64,900 in 2015, with fewer people leaving for Australia and more arrivals from across Asia.