New Zealand’s Central Bank Leaves Cash Rate at 2.5% and Delivers Dovish Statement

January 27, 2016

The statement from the Reserve Bank of New Zealand arrived an hour after the FOMC statement and reveals more about the market’s angst over Fed tightening than about New Zealand.  Both central banks left key interest rates unchanged in January, which wasn’t a great surprise since each had changed rate levels at the previous policy meeting in December.  The problem is that in December, the Fed tightened, while the RBNZ cut its rate.  The reduction of 25 basis points was the fourth 25-bp decline since last June, a cumulative cut of a whole percentage point.  Both the United States and New Zealand have sub-target inflation, but policymakers in each central bank project a rising inflation trend in the medium term.  Growth is projected to be moderately positive in both economies, dampened in part by currencies that are stronger than officials would like.  Baseline forecasts must be balanced against considerable risks that on balance seem skewed somewhat to the downside.  A passage from the RBNZ statement can be said about many economies including the United States, and it suggests that the prudent thing to do is to be very, very cautious when inflation remains quite low relative to target and in the face of tremendous global financial market turbulence:

Headline inflation is expected to increase over 2016, but take longer to reach the target range than previously expected. Monetary policy will continue to be accommodative. Some further policy easing may be required over the coming year to ensure that future average inflation settles near the middle of the target range. We will continue to watch closely the emerging flow of economic data.

So U.S. and global investors rightfully are wondering what makes the situation in the United States so exceptional that faced with similar parameters to those in other economies.  Why is the FOMC so anxious to raise the federal funds rate by 100 basis points in 2016 when the crowd of monetary policymakers elsewhere are sitting back and deciding either to hold the line on rate or to ease?  And here is the answer being drawn.  Fed officials are worried that when the next U.S. recession comes, as it will inevitably, they will not be in a position to react with enough stimulus.  Tightening policy — and yes, a move from a very accommodative stance to a less accommodative one constitutes a tightening just as surely as going from minus 9 to minus 8 represents an increase — so that you can ease it later is a much lamer reason from raising the federal funds rate than lifting the central bank rate to avoid an unhealthy swing of inflation to significantly above its target.  The Fed’s got to do what it believes to be right, but it is entirely understandable for the investment community to be alarmed that Fed policy is following a less intuitive path than the majority of other central banks that are grappling with an oil price plunge that was not foreseen.

Copyright 2016, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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