Reserve Bank Governor Adrian Orr walks away from his Monetary Policy Statement press conference yesterday and into a clash with National's Nicola Willis over the inflationary imapct of the Budget.

The Reserve Bank Governor and the Bank’s Monetary Policy Committee yesterday ended up at odds with National’s Finance spokesperson, Nicola Willis, over whether the Budget was inflationary.

Willis said it was.

The exchange is looking like a significant test of Willis’s economic credibility.

The MPS statement and the Governor’s media briefing yesterday afternoon went to some lengths to explain why the Bank believed Government spending was not inflationary, as Willis kept claiming, but the opposite; contractionary.

She, however, pointed her finger squarely at the Budget as fuelling inflation.

The trouble was that she used a highly selective quote from yesterday’s Monetary Policy Statement to justify her position.

“The Reserve Bank’s Monetary Policy Committee warned everyone in February that risks to inflation from fiscal policy were ‘skewed to the upside’,” her statement said.

“Since then, Grant Robertson has only poured more fuel on the fire with the RBNZ noting in today’s report that ‘fiscal policy is projected to add to demand over the 2023/24 fiscal year’ and ‘fiscal policy is projected to be less contractionary than the Committee had assumed in February.’

But that was only half the story.

The paragraph she quoted actually arrived at a different conclusion.


“Fiscal policy is projected to add to demand over the 2023/24 fiscal year, “ it said as she quoted.

But the sentence continued: “then dampen demand in subsequent years.”

She left that bit out.

“Overall, fiscal policy will be contractionary on demand over the projection horizon,” it said.

“This reflects that government consumption, which is the larger share of government spending, is expected to fall as a share of GDP in coming years.

“Government investment is expected to continue to grow, in part due to the repair and rebuild work in the aftermath of the weather events.”

The paragraph then concluded with the line about fiscal policy being less contractionary than the February MPS had assumed, which she did quote correctly.

“The most important thing and really the only relevant thing for monetary policy is that the outlook for fiscal spending is contractionary on demand, so that is what has been factored into our outlook ahead,” Governor Adrian Orr told the media conference.

“Yes, there is an increase in government investment for very obvious reasons, mostly driven by recoveries through the cyclone period.

“But broad government spending, once you add  government consumption, is actually declining as a proportion of GDP throughout the forecast period.”

So the Bank believes that the increase in Government spending is a consequence of an increase in capital spending because of the cyclone.

 It was a point Orr repeated during the media conference.

“What we’ve seen is that as a per cent of GDP, it (Government spending) is declining; it’s being more of a friend than foe to monetary policy at this point in time,” he said.

“And we totally understand the challenges that society is going through and the government and spending investment that is needed.

“So, and I’ll repeat, it is not contractionary through the forecast period, and that is what most matters for our decision-making on monetary policy.”

Willis might take some solace in the fact that the trading banks are not totally convinced by the Reserve Bank’s view of the Budget.

ANZ economists Sharon Zollner and David Croy addressed the same paragraph that Willis quoted from.

“The RBNZ noted in April that expansionary fiscal policy represented an upside risk to growth and inflation,” they said.

“It’s not clear what numbers the RBNZ had in mind going into the Budget. However, their conclusion is now that fiscal policy is projected to be less contractionary than assumed in February.

“That’s a pretty different tone to “inflationary”, which is how analysts have generally interpreted it to be in a stretched economy.”

Ironically one of the reasons for the Reserve Bank’s view was that inflation was reducing the real increase in Government spending.

“While fiscal policy is projected to add to demand in the 2023/24 fiscal year, the effect of high inflation increasing the cost of delivering government services means that real government consumption as a share of GDP decreases across the rest of the forecast period, thereby dampening demand,” they said.

“Real government investment is expected to continue to increase, reflecting the recovery from Cyclone Gabrielle, but capital expenditure is less inflationary than consumption.”

Despite this, the Bank’s Monetary Policy Committee raised the official Cash Rate yesterday to 5.5 per cent.

POLITIK Member sof the Monetray Policy Committee at yesterday’s Reserve Bank MPS briefing. (From left) Peter Harris; Bank Deputy Governor, Christian Hawkesby; Professor Caroline Saunders and Professor Bob Buckle.

And, despite the contractionary effect of the Budget, the Bank is forecasting the OCR  to stay at 5.5 per cent till June 2024 and then fall faster than it had previously forecast to be down to 3.31 per cent by June 2026.

But it is sobering to realise that Australia’s Official Cash Rate is already at 3.85 per cent.

The New Zealand OCR has a significant political impact through its effect on housing mortgage rates.

“Today’s hike alone in interest rates means an additional $1250 a year for a family with a $500,000 mortgage,” said Willis.

Orr, however, doubted that the OCR rise would have that much of an impact because Banks had already been pricing in rises.

“The message is that we’re getting on top of inflation, and inflation is the number one driver of nominal interest rates,” he said.

“And so that should bring longer-term relief to people around the level of mortgage interest rates.

“The second part is we don’t believe today’s decision should be altering the level of mortgage interest rates.

“Banks have been very good at the front-running expected changes in the official cash rate, so all we’ve done is only partially meet what was already priced into the market for mortgage interest rates.”

Orr said that the banking system was now about three-quarters of the way through refixing the massive number of mortgages that required refixing this year.

It has been estimated that over half of all mortgages would require a refix.

“So I hope that a lot of the awareness is already on board,” he said.

“We’ve seen that with very low levels of non-performing loans and all of that.”

Through mortgage rates, the OCR has a powerful impact on house prices, and here, the Reserve Bank and Treasury have a substantial difference over what might happen.

In last week’s Budget Economics and Fiscal update, Treasury forecasted a peak-to-trough fall in house prices due to higher interest rates of 21.3 per cent, with the market reaching the bottom in June next year.

The Reserve Bank, on the other hand, has forecast that house prices will fall only 17 per cent peak-to-trough, with the bottom coming in the last quarter of next year.

What complicates the house price forecasts is the potential impact of increased migration.

The former ACVT leader, Richard Prebble, in a strongly worded op-ed in yesterday’s NZ Herald, pointed out the pitfalls of unlimited immigration.

“Immigration is why the average house in Auckland costs a million dollars,” he wrote.

“Immigration creates a wealth effect.

“It is fool’s gold.

“It fooled voters into re-electing John Key.

“Chris Hipkins hopes it will fool voters into electing him.”

In this month’s Economic Overview, Westpac forecast that net migration could reach 100,000 by the end of this year.

The Overview suggested this would impact the housing market.

“It’s looking like a trough in the housing market is approaching faster than previously anticipated,” it said.

“Since mortgage rates began rising in 2021, house prices have fallen by an average of 17% across the nation.

“However, rising population growth along with lower longer-term mortgage rates are likely to provide a brake on those declines.

“We’ve revised up our forecasts for house price growth, and now expect that mid-2023 will be the bottom for the housing market.”

But Orr yesterday was discounting the immigration effect.

The Monetary Policy Committee was picking net migration to be back to pre-covid levels by the end of the year.

“A big part of the immigration we’ve seen has already happened,” he said.

“But the big surge has happened and is already behind us.

And our projection is that surge eases off; a lot was pent-up demand,

“So all of that working its way through.

“A big part is around migrant visas. Those who may be picking those up are already here in New Zealand.”

The Governor – and the Monetary Policy Committee — were not to know that Willis would react the way she did to their Statement.

But that she did, the way she did, now means that the Bank is now a participant in the political debate in the run-up to the election.