The Reserve Bank is prepared to cut its official cash rate below the current 2.5% should concerns deepen around the prospects for the global economy and its impact on New Zealand.
But there will be no knee-jerk reactions to data releases.
Governor Graeme Wheeler used his speech to the Canterbury Employers Chamber of Commerce yesterday to emphasise the central bank would continue to draw on the flexibility contained in the price targets agreement (PTA) in managing economic risks and assessing monetary policy.
The Reserve Bank has an agreement with the Government to keep inflation between 1% and 3% with a mid-point target of 2%. Inflation is running at 0.1%.
Mr Wheeler said the bank would avoid taking a mechanistic approach to interpreting the PTA.
‘‘Some commentators see a low headline inflation number and immediately advocate interest rate cuts. A mechanistic approach can lead to inappropriate fixation on headline inflation.''
The mechanistic approach would cut across the flexibility deliberately built into the PTA framework and risk creating serious distortions in the financial system, housing market and broader economy, he said.
A flexible approach was necessary in view of the numerous factors the bank was required to consider in the PTA - such as asset prices, financial stability and efficiency, volatility in output, interest rates and the exchange rate.
‘‘All of these factors have bands of uncertainty attached to them. There are also uncertainties as to which transmission channels monetary policy will operate through and the lags involved in achieving desired outcomes.''
The current annual headline inflation rate of 0.1% was primarily because of the negative inflation in the tradeables sector and the fall in oil prices, in particular, Mr Wheeler said.
Low oil prices were recognised in the PTA as a factor legitimately causing inflation to be outside the target band.
It would be inappropriate to attempt to offset the low oil price effect through the OCR, which tended to influence inflation outcomes over an 18-month to two-year horizon.
The bank's goal was to anchor inflation expectations close to the mid-point of the price stability range, while retaining discretion to respond to inflation and output shocks in a flexible manner.
‘‘Looking ahead, monetary policy will continue to be accommodative. With the ongoing weakness in commodity prices, and particularly oil, it will take longer for headline inflation to reach the target range.''
●The Reserve Bank of Australia held its official lending rate at 2% on Tuesday.
