PREFU 2002 and Comments by Finance Minister Cullen
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PREFU 2002 and Comments by Finance Minister Cullen on the RBNZ
As required by the Fiscal Responsibility Act, the Government today released its Pre-Election Economic and Fiscal Update
(PREFU). Coming just 5 weeks after the Budget, little change in the Treasury's economic and fiscal projections was
expected with the main development being the unexpected strengthening of the NZD. Therefore, not surprisingly, the
Treasury now project marginally weaker growth, marginally lower inflation, and a more substantial deterioration in the
current account deficit. As a result, the projected fiscal surpluses are marginally weaker. However, the Government
anticipates no changes to the Bond programme at this stage, with the 2002/03 programme remaining $3.4bn.
Aside from releasing updated projections (set out in more detail in the table below), Finance Minister Cullen also took
the opportunity to step up his criticism of the RBNZ. In part, we think this reflects genuine concerns that the
Government has about the handling of monetary policy (in the recent context, the Bank's willingness to lead the world in
the race to retighten policy settings). However, in our view, the timing of the comments also likely reflects the fact
that the Government is now in `Election mode', and criticism of the RBNZ - especially with former RBNZ Governor Brash
now a candidate for opposition National Party - is unlikely to be a vote loser. Indeed, the criticism is likely to be
received well by many (the populist New Zealand First party is also on this bandwagon).
In terms of detail, Dr Cullen noted that the Bank's interpretation of the Policy Targets Agreement differs from that of
the Government. In particular, the Government expects the Bank to use the full width of the 0-3% target band, rather
than always aiming to move inflation back to the 1.5% midpoint. While Dr Cullen does not envisage widening the band, he
did indicate that the Policy Targets Agreement may need some amendment when a new agreement is signed with the
still-to-be-appointed replacement Governor. Should this occur, we think this may involve moving the RBNZ's target
further in the direction of that pursued by the RBA - in particular, requiring the Bank to achieve 0-3% `over the
economic cycle' rather than at all times, thus adding an additional degree of flexibility.
In our view, with the Labour Government enjoying a huge lead in the polls and virtually certain to be re-elected,
markets should be pricing the probability that, post election, the Government will achieve one or both of (a) a more
flexible Policy Targets Agreement (b) a more flexible Governor. This need not mean higher trend inflation over time
(although at the margin, we suspect it probably does). However, it does mean that the Bank will tolerate greater
variance of inflation with the 0-3% target range (indeed, the Bank has already moved in this direction over the past two
years). In practice, this is likely to mean a more gradualist approach to setting interest rates.
It remains to be seen whether this criticism - which is perhaps the most explicit public criticism of the RBNZ that we
have seen from a Finance Minister since the Reserve Bank Act was implemented - has an impact on the Bank's short-term
policy making. The market is close to fully priced for a 25bp hike at next week's interim review and this is also the
expectation of all analysts included in a recent Reuters poll, including ourselves. Given Dr Cullen's comments, a
decision by the Bank not to tighten next week will no doubt be seen as the result of political interference, even if
there are valid economic reasons why the Bank might have already decided to leave the OCR unchanged. Indeed, even before
today we felt that there was a 25% chance that the Bank would skip next week's meeting, mainly due to the unexpected
tightening of conditions that had occurred as a result of the appreciating NZD, together with increasing uncertainty
about the pace of the US recovery and its implications for Asia. On balance, we think that the prospects for next week
are largely unaltered, but today's comments reinforce our view that the market is currently too pessimistic about the
amount of tightening that will take place over the coming year. We look for the OCR to peak at 6.25% by year-end.
Darren Gibbs, Senior Economist,
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