Reserve Bank ‘jawboning’ must continue
The past few weeks has been all about the global banking system, bank failures with Credit Suisse the most spectacular, and potential bank failures perhaps including Deutsche Bank which may negate my earlier comment re Credit Suisse!
We’ve also had a few months now of slowing economies, including a surprising contraction here in NZ in the past quarter, most evident in layoffs beginning to occur (Amazon, Microsoft, Meta, Sky TV etc) as last years sharp increases in interest rates begin to bite.
Banking wobbles and slowing / contracting economies or the threat thereof have historically tended to bring about interest rate cuts to “cushion” the blow if you like. What about this episode and are we likely to see interest rates around the world and here in NZ stop rising or indeed fall?
“Jawboning” is the term referring to an unconventional tool used by Central Banks to augment their traditional lever of moving interest rates around to manage inflation and in some cases growth. Effectively “jawboning” amounts to verbal messaging, designed to alter behaviour in the direction that the Central Banks want. During the fearful Covid period after drastic interest rate cuts were completed, Central Bank messaging was all about soothing the markets and assuring investors that interest rates would be kept low for an extended period. This messaging and low-rate environment was supposed to stimulate investment and encourage investors to make long term investment decisions without worrying about higher interest rates in the future – thus ensuring the economy kept humming. Well, the economies may not have hummed but at least they didn’t slump. (Asset prices hummed…)
How things have changed as we fast-forward from the Covid world to last week, where Reserve Bank of New Zealand (RBNZ) Chief Economist, Paul Conway, made an interesting speech to a Capital Markets forum in Wellington.
Conway’s central point was that on a per-person, real basis, New Zealanders are now relatively poorer because the quantity of goods and services that can be supplied by the market and therefore available to purchase at a given price level is falling: ie our dollar is not going as far as it once did and that we all had better get used to it. This decline is essentially the result of supply-shock driven inflation such as we have seen globally over the last couple of years. This is what happens when you shut down industry and commerce on and off for a couple of years…
For its part, the RBNZ promised to respond to the current inflationary environment with its blunt instrument of higher interest rates, effectively discouraging/preventing consumers from spending by increasing the drain on the pocket from debt-servicing costs, in order to ensure that there is no or reduced excess demand for the (now reduced) supply of goods and service. Hey presto, inflation problem solved – but a tough message for NZs to absorb.
Unlike in 2020, here the promise is to do “whatever it takes” to curb inflation. If NZers want a feeling of prosperity, they will have to do it the old-fashioned way, by improving productivity. On this metric, our track record is poor. From 1996 to 2021, the average annual growth in labour productivity in New Zealand was 1.3%, compared with 1.9% in Australia. That may sound like a small annual difference, but over a 25-year period, it adds up to a lot and translates directly to higher per-person incomes in Oz.
Hard-hitting stuff, and many will have taken Conway’s speech at face value. The RBNZ certainly doesn’t want people looking ahead to a period of potentially lower interest rates and behaving accordingly. It wants consumers and businesses to listen, act more conservatively, refuse to pass-on price increases, and spend less. But as with its reactions after Covid, by making the right public noises, the RBNZ probably hopes that it won’t have to actually deploy the extra interest rate hikes it alludes to. If it can “jawbone” and get the job done with words, all the better.
This imperative is especially true in the current environment where banks around the world are under pressure. I would agree with observations that the banking system has really cleaned up its act since the Global Financial Crisis, and this is especially the case in Australia and NZ where the supervisory framework is very strong and balance sheet risks well managed. But the RBNZ will definitely have one eye on the situation and be at least a bit wary of overdoing it. Historical evidence indicates that supply-shock driven inflation spikes can collapse very rapidly. Unemployment data, which is one of the RBNZ’s primary concerns right now, is a very lagging indicator increasing unemployment today means activity slowed earlier. The quarterly rather than monthly cycle of NZ economic data releases also means it’s possible a sharp slowdown won’t be evident until it’s well and truly in progress. And I reckon that is right now.
A final point on interest rates, since this coming week the RBNZ will be issuing its latest decision Monetary Policy Statement: with the recent rhetoric from a senior member of the institution, a 0.25% increase must be a fait accompli, especially as the markets currently have this priced-in. But as usual, the commentary will be carefully parsed for evidence of a change in the thought process. I conclude that we’re not quite there yet and the “jawboning” for tighter conditions and behaviour will continue.
