The latest New Zealand Reserve Bank update says that prospects for growth in the global economy have diminished despite very stimulatory monetary policy and low oil prices. Significant downside risks remain. Financial market volatility increased following the UK referendum and long-term interest rates have fallen.
Domestic growth is expected to remain supported by strong inward migration, construction activity, tourism, and accommodative monetary policy. However, low dairy prices are depressing incomes in the dairy sector and weighing on farm spending and investment.
There continue to be many uncertainties around the outlook. Internationally, these relate to the prospects for global growth and commodity prices, the fragility of global financial markets, and political risks. Domestic uncertainties relate to inflation expectations and the potential for continued high net immigration, ongoing pressures in the housing market, and the high New Zealand dollar exchange rate.
The trade-weighted exchange rate is 6 percent higher than assumed in the June Statement, and is notably higher than in the alternative scenario presented in that Statement. The high exchange rate is adding further pressure to the dairy and manufacturing sectors and, together with weak global inflation, is holding down tradable goods inflation. This makes it difficult for the Bank to meet its inflation objective. A decline in the exchange rate is needed.
House price inflation remains excessive and has become more broad-based across the regions, adding to concerns about financial stability. The Bank is currently consulting on stronger macro-prudential measures aimed at mitigating risks to financial stability from the current boom in house prices.
Annual CPI inflation was 0.4 percent in the year to June 2016. Headline inflation is being held below the target band by continuing negative tradables inflation. Long-term inflation expectations are well-anchored at 2 percent, but short-term inflation expectations remain low.
Despite rising capacity pressures and some recent increase in fuel prices, the stronger exchange rate implies that the outlook for inflation has weakened since the June Statement.
Monetary policy will continue to be accommodative. At this stage it seems likely that further policy easing will be required to ensure that future average inflation settles near the middle of the target range. We will continue to watch closely the emerging economic data.
