OCR stays at 3% – but beware of the pipeline effect.

On Thursday the Reserve Bank left the official cash rate unchanged at 3% and said further rate hikes would be more moderate than previously flagged as Canterbury’s earthquake undermines economic growth and fans inflation. However there are concerns that the RBNZ appears just too relaxed about the many inflation threats ahead. With the potential for supply pressures as the economy nears its productive capacity underlying price and wage inflation can only go upwards.
The RBNZ has indicated in recent policy statements that monetary policy is continuing to provide stimulus to the economy with more liquidity. This followed a substantial amount of easing in monetary policy since mid-2008, with 575 basis points of decreases in the OCR. The amount and persistence of this stimulus is determined by how far below the neutral* interest rate the current level of interest rates are and for how long. Having a better idea of the likely neutral level for the OCR will help guide the RBNZ’s decision-making as it starts to move interest rates higher with the objective of withdrawing all the stimulus put in place in response to the Global Financial Crisis.

*The neutral interest rate is supposedly one where monetary policy is neither contractionary nor expansionary. Another explanation refers to the level of the OCR that would deliver stable inflation and inflation expectations at the inflation target, and an output gap at zero and expected to remain zero over the medium run (i.e., the economy is operating at its full potential).

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