RBNZ commitment to inflation target crucial for believable guidance, Bascand says

Friday 6th December 2013

The Reserve Bank's inflation target is crucial if it wants the private sector to believe its projected interest rate path, and means the monetary authority needs consistent communications, deputy governor Geoff Bascand says.

The central bank is mandated to provide a type of forward guidance in its policy statements, which is typically the future track of the 90-day bank bill rate, which creates greater certainty for households and firms, Bascand said in a speech in Auckland.

Future policy decisions are typically linked to economic conditions, which in New Zealand's case will likely see short-term interest rate differentials widen because of its burgeoning economic recovery relative to its peers and trading partners, he said.

"The communication challenge with forward guidance - which equally applies to publishing interest rate projections - is how to reduce uncertainty about the likely path of policy while at the same time conveying its conditionality and the possibility of change in policy settings," Bascand said. "Achieving this depends crucially on the private sector believing the bank's unwavering commitment to the inflation target."

New Zealand's central bank has already signalled interest rate increases are likely next year as the rebuild in Canterbury and housing boom in Auckland threaten to fuel inflation, though governor Graeme Wheeler has said that's dependent on whether the currency depreciates from what the bank views as an over-valued level.

Bascand said one the bank's tests of whether it communicates effectively is how the market responds, though that doesn't automatically mean the public will have the same understanding as the financial sector.

"A recent foray into the 'public audience' via an opinion article explaining the LVR (loan-to-value ratio) policy, that repeated our monetary policy expectations, appeared to reveal substantial public surprise about our interest rate projections," Bascand said. "While unintentional, it therefore possibly enhanced the projection's impact."

In October, the bank introduced restrictions on low-equity lending as a means to dull the risk to the country's financial stability from the bubbling property market without having to resort to hiking rates, which might have boosted the New Zealand dollar.

"We have reiterated that LVRs are targeted at the primary objective of financial stability, but that there is also a potential benefit for monetary policy if they reduce the spillover of house price inflation into stronger consumer demand and higher price inflation for goods and services," Bascand said. "Explaining important inter-dependencies with other policies - our own or wider government ones - is vital."

BusinessDesk.co.nz

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