Governor Anna Breman says Reserve Bank unlikely to lift interest rates directly in response to oil price spikes

Reserve Bank Governor Anna Breman says the central bank is unlikely to hike the Official Cash Rate directly in response to oil price spikes pushing up inflation.

However, she recognises high oil prices caused by conflict in the Middle East could eventually push businesses to lift their prices, and employees to demand higher wages, even if the economy is sluggish.

In this instance, New Zealand “could still see higher inflation in the medium term”.

Given the Reserve Bank is required to keep the annual inflation rate between 1 and 3% in the “medium term”, inflation becoming embedded could prompt the Monetary Policy Committee to hike the OCR earlier than it otherwise would have.

Breman provided this assessment in a speech, published this morning ahead of being delivered at a Business New Zealand CEO forum this afternoon.

She said the shock had sent waves through complex global supply chains, and it would take time for the full effect to play out.

“We should try to avoid reacting too early to near-term inflation pressures that monetary policy can do little about – or reacting too late if above-target inflation becomes embedded in the economy,” Breman said.

“To meet our core mandate of price stability, monetary policy can and should ensure that a near-term inflation spike does not turn into enduring inflationary pressures.

“The committee will be vigilant to this risk.”

Breman said that over coming months, the committee would look closely at the “second round impacts” of higher oil prices to understand how the balance of inflationary pressures is likely to evolve.

Accordingly, it would keep a close eye on surveys that show how businesses are likely to increase their prices and wages.

Breman didn’t want to pre-empt the outcome of the next OCR review, set down for April 8. Rather, she wanted to outline the Reserve Bank’s thinking.

“Our target is forward looking, meaning it is the medium-term outlook for inflation that guides our monetary policy decisions,” she said.

“This means balancing higher near-term inflation and potentially higher inflation expectations against a weaker growth outlook.

“Key to this balance, the duration of the shock is an important factor in considering the appropriate monetary policy response.”

Breman’s speech tempered financial markets a little.

They had been reacting strongly to the prospect of higher oil prices seeing inflation bed in.

Indeed, wholesale interest rates had risen sharply, prompting banks to lift some of their mortgage and term deposit rates.

Meanwhile, markets had priced in a 20% chance of the OCR being hiked on April 8, and a 100% chance of it rising by July.

Following Breman’s speech, markets priced in a 12% chance of an April hike, a 50% chance of a May hike, and a 100% chance of a July hike.

In February, before conflict escalated in the Middle East, the Reserve Bank pencilled in its first OCR hike for later in the year. This would see the OCR be a little less stimulatory than it currently is, at 2.25%.

Local economists typically don’t see the OCR rising as quickly as the market does. They are wary the sluggish economy might limit the extent to which businesses will be able to pass higher costs onto their customers.

Coming back to Breman, she said fiscal policy (ie the tax and welfare system, which the Government controls) was best placed to support households most vulnerable to price increases.

However, she stressed that any support should be targeted, timely and temporary to avoid putting upward pressure on inflation.

Jenée Tibshraeny is the Herald’s Wellington business editor, based in the parliamentary press gallery. She specialises in government and Reserve Bank policymaking, economics and banking.

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