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Remarks to Directors and Senior Officers of Deposit Takers and Insurers

Delivered by Christian Hawkesby, Deputy Governor and General Manager for Financial Stability, in Auckland on 13 and 14 December 2022.

E ngā mana, e ngā reo. E ngā karanga maha o te wā.

Tihei mauri ora!

It’s a pleasure to be speaking to you this evening as the directors and senior officers of the financial institutions that we regulate. We all share a responsibility to ensure that the financial system continues to be an engine for the prosperity and wellbeing of the people of New Zealand that we all serve.

I’ve been asked to talk about the economy and outlook as a member of the Monetary Policy Committee. I’ll draw in part on the themes of our most recent Monetary Policy Statement.

However, firstly I’d like to congratulate you all for navigating yet another unprecedented year, and continuing to support your customers.

As an exercise in humility, at the end of each year I like to look back at what the market was expecting 12 months earlier.

In the case of the US Fed Funds Rate, this time last year the market was expecting it to be around 0.5% by now. That’s 0.5%, not the 5% it’s been fast approaching. That gives you a feel for how radically different this year has turned out than was expected.

It was fairly early in 2022 that I had my surreal moment of the year, having thought the arrival of Covid-19 in early 2020 would be hard to beat.

It was late February. I was filling in for the Governor at a briefing of public sector Chief Executives. We were all wearing masks and sitting a metre apart, as the country was about to experience its biggest wave of Covid-19 infections since the start of the pandemic. We were being briefed about one of the largest global energy producers and nuclear powers invading one of the largest global food producers, in a conflict that would likely last for months or years rather than days or weeks. And to get to the briefing I’d had to walk through protesters that were occupying the grounds of parliament and about to riot. All a cobblestone’s throw from the RBNZ building.

You all know the global story from there.

Average annual CPI inflation now sits at around 10% across the OECD.

While we are in the lowest quartile for inflation and unemployment in New Zealand, that is little consolation when CPI inflation is running over 7% and expected to stay elevated for many quarters ahead.

The biggest challenge facing our economy at the moment is constraints on the supply side. The shortage of workers is the most acute constraint on the economy. You don’t have to follow business surveys to see this. I am sure you see it in your own business. If not, when you walk down the street and see the signs on the windows of cafes and restaurants. Or even the disruption to trains, taxis and airlines.

We are often asked whether we are experiencing a dreaded wage-price spiral, not seen since that the 1970s and 80s.

The answer is that wage inflation is doing what any economic model would predict given the level of consumer price inflation and tightness in the labour market.

But from our perspective, what really matters is if prices are increasing at a rate that is inconsistent with our inflation target, we need do to something about it.

And our tools can help moderate demand to bring it more in line with the ability of the supply side of the economy to meet that demand.

That’s been the story of 2022, and it has only intensified as demand and inflation pressures have continued to surprise to the upside.

In May we talked about demand growth needing to moderate to let the supply side catch up.

In August we talked about demand needing to be flat for a period to let the supply side catch up.

By November we talked demand needing to contract for a period to let the supply side catch up.

It’s been pretty confronting to start this conversation about the prospects of a recession in the period ahead, but it’s been important to highlight how stretched things have got and the implications and trade-offs it creates.

We are also often asked when we will know we have done enough monetary tightening, given the lags between an OCR decision and when it bites. 50% of mortgage books are yet to roll over, and some borrowers will reset from 2.5% to 6.5%.

The answer is that we still think we have more work to do.

We’ve seen very little impact of higher interest rates so far, outside of falling house prices and a cooling of the construction pipeline.

As inflation expectations have been rising, we also think that neutral interest rates have drifted higher, meaning that the OCR needs to be higher than otherwise before monetary policy is really restricting the demand side of the economy.

We are also conscious that if we don’t get on top of the inflation challenge at pace, then there is a danger that we would have even more work to do in the future, and the greater damage that could do to the economy and financial system.

The good news is that we meet every 6 weeks for most of the year, relooking at the data, evidence, and global developments.

We are also very aware that monetary policy works through the financial system.

So, our relationships with you are going to be crucial, building together the intelligence on what you are seeing, and what it tells us about whether or not the tightening in monetary policy is working to acheive our mandate.

Internally we are strengthening the connections between our economists and supervisors, to ensure they are well armed for those two-way conversations.

So where might things stand in 12 months’ time when we meet at this event again?

The projections that we published in November had the Official Cash Rate peaking around 5.5%.

However, 25 years as an economist has taught me that the only certainty is that our forecasts won’t be exactly right. There are always shocks and unexpected developments that will evolve the story.

Going back to the global environment and the example of the US Fed Funds Rate, if expectations are that it peaks around 5% sometime next year, I can see a plausible scenario where its somewhere between 3% and 7% by the end of next year. 3% if the tightening in monetary policy so far bites and inflation pressures abate quickly. And 7% if demand remains surprisingly resilient and inflation pressures are more stubborn.

It’s that range of uncertainty that we live with that underlines why it’s so important to build resilience in our financial system.

To ensure that you continue to have the confidence take a long-term view, and support your clients and customers through the ups and downs.

To ensure that the financial system continues to be an engine for the prosperity and wellbeing of the people of New Zealand that we all serve.

Kia kaha, kia maia, kia manawanui, kia ora, meri Kirihimete me nga mihi o te tau hou.

Be strong, be bold, be patient, be well, and have a sensible spending Christmas and a happy new year.