Conway: Inflation risk persists, RBNZ may need firmer response
Reserve Bank of New Zealand (RBNZ) Assistant Governor Paul Conway highlighted the risk of temporary inflation shocks becoming persistent. Speaking on July 13, Conway noted that while near-term pressures from oil prices have eased, the Middle East conflict still poses a significant inflation challenge.
Oil shocks and pricing power
RBNZ Assistant Governor Paul Conway noted that near-term inflation pressures have eased due to falling oil prices, reflecting some progress in the Middle East.
However, the conflict has still delivered a significant inflation shock, and the challenge for monetary policy is to prevent this from leading to persistent inflation.
Drawing on recent RBNZ research, Conway explained how oil price shocks can transmit to broader inflation through firms' pricing decisions and the expectations of businesses and households.
He highlighted that when inflation is high, businesses pay closer attention and are more inclined to pass on cost increases, while being less likely to reduce prices when costs ease.
This dynamic, Conway warned, raises the risk of temporary shocks becoming persistent.
Anchors and spare capacity
Conway emphasized that if above-target inflation alters expectations and price-setting behaviour, monetary policy may need to respond more firmly to re-anchor inflation expectations.
He noted that, encouragingly, medium-term inflation expectations are currently well anchored, and existing spare capacity within the economy should help limit the pass-through of cost increases.
However, after a prolonged period of above-target inflation, Conway cautioned that anchored inflation expectations cannot be taken for granted.
The Monetary Policy Committee (MPC) last week indicated that with inflation still above target and economic activity expected to strengthen, some further reduction in monetary stimulus is likely to be required.
A delicate balance
Conway's speech reveals the RBNZ's delicate balancing act: recognizing easing pressures while signaling readiness for firmer action if needed.
The focus on firms' pricing power and the fragility of anchored expectations highlights the persistent challenge for policymakers.
This stance aims to manage inflation expectations without pre-committing, reflecting a vigilant but data-dependent approach.