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Inflation is likely to stay “sticky” for a year or two more, the Reserve Bank indicated today.����

In an atmosphere of��high inflation and sluggish economic growth, the Reserve Bank (RBNZ) has outlined plans to get the country back to 2 per cent inflation.����

RBNZ chief economist Paul Conway delivered a speech on inflation this morning, a day before��first quarter GDP results��are due.��

Asked if restrictive monetary policy was damaging the economy and causing people to leave for Australia, he said: “That mission is causing the economy to grow more slowly than it otherwise would, so we are experiencing some short-term pain”.��

He queried whether the central bank’s policy could be blamed for people “fleeing” the country.��

“Think hard before jumping,” he said, indicating that New Zealand’s long-term economic prognosis was good.��

“It’s nowhere near as bad as it was a year or so ago,” he said of inflation.��

Conway outlined how the Reserve Bank monetary police committee (MPC) had to keep annual Consumers Price Index (CPI) inflation between 1 and 3 per cent.��

CPI inflation in the first quarter was up 0.6 per cent on the December 2023 quarter and up 4.0 per cent year-on-year.��

Though not a perfect measure, the CPI is widely regarded as the most comprehensive and reliable gauge of inflation.��

Conway discussed how the country might achieve 2 per cent inflation over what he called the “medium term” while avoiding unnecessary instability.��

He said in most cases the MPC aimed to get inflation to 2 per cent within one to three years.��

OCR strategy��

Reserve Bank Governor Adrian Orr is presiding over an era of rising inflation and interest rates. Photo / Mark Mitchell��

Conway outlined how the Official Cash Rate (OCR) was used in an inflation-fighting strategy.��

“This approach recognises that changes in the OCR take time to transmit through the economy and influence inflation.”��

He said the Reserve Bank did not want to cause unnecessary economic volatility by changing interest rates in response to inflation blips that would fade naturally in time.��

“Growth will improve but there’s a cascading series of events working through the economy for interest rates to influence inflation.”��

It could take 18 months to two years for OCR changes to meaningfully impact the economy, but he added: “If we change the OCR, markets react virtually instantaneously.”��

Conway said a tight labour market and supply shortages were the biggest contributors to inflation during the Covid-19 pandemic.��

But now the two most important factors in an expected non-tradeable inflation slowdown were spare capacity in the economy, and lower inflation expectations from households and companies.��

Non-tradeable inflation measured final goods and services that do not face foreign competition.��

“We expect spare capacity to start emerging in the economy over 2024, after several years of the economy growing well beyond its sustainable rate,” Conway said.��

“We expect this spare capacity to feed through strongly into lower domesticallygenerated inflation.”��

Border closures from 2020 to 2022 made the local labour market tight as workers were in short supply but reality had changed dramatically since then, Conway said. Photo / Alex Burton��

As for people’s expectations, Conway said RBNZ research found that above-target inflation in recent years prompted people to pay more attention to inflation and to update inflation expectations more frequently.��

“Inflation expectations - they can become self-fulfilling,” he said.��

“Lower inflation expectations and a lower propensity for firms to make relatively large price increases will help lower inflation persistence.”��

The RBNZ now expected disinflation to spread across a wider set of non-tradeables that typically take longer to react to monetary policy - such as restaurant meals and ready-to-eat food.��

Conway said overall, good progress was being made in bringing inflation back to target.��

An increasingly loose labour marker would be pivotal to that, he said.��

But it seemed anybody expecting a cut to interest rates should think again.��

“Overall, a period of restrictive policy is necessary to give us confidence that inflation will return to target over a reasonable timeframe.“��

And despite all the research, it was still anybody’s guess when the county might climb out of the high inflation quagmire.��

“These processes could occur more quickly or slowly than currently projected.”��

Sluggish data��

On spare capacity forecasts, Conway said: “We’ve got quite a reasonable read on what’s going on in the labour market.”��

He said the country needed better economic data. Many key data releases lag real-time events and are prone to revision.��

Tomorrow’s GDP data, for example, will be more than two-and-a-half months old.��

“Sometimes it can be difficult to tell what’s going on.”��