Roger J Kerr weighs the economic and inflation factors facing the Reserve Bank

By Roger J Kerr

The local interest rate market should be looking for four major issues affecting the 2018 economic and inflation outlook in this week’s Monetary Policy Statement from the Reserve Bank of New Zealand, namely:

Currency depreciation:
Current RBNZ currency assumptions for their 2018 inflation forecasts is the Trade Weighted Index (TWI) averaging 77.50 through the year. Today the TWI is 5% lower at 73.40 and the question is when and by how much importers/retailers of consumer goods increase their prices. The time lag is normally six to nine months due to importer currency hedging.

Anticipated wages pressures:
It is a common phenomenon around the world that tighter labour markets over recent years have not caused significant wages increase and thus inflation remains stable at low levels. Wage increases have been muted in New Zealand to date as well, however, the forward outlook has changed dramatically with the change of government. The new minimum wage increases will cause relativity issues for other more experienced workers. The new restrictions on immigration will reduce the labour supply and push up wages. Even though the NZ economy is now only 20% unionised, the big public sector unions of teachers and nurses will certainly be pushing for material wages increases. The US is currently increasing their short-term interest rates as the Federal Reserve anticipate that inevitable wages increases will feed into the wider inflation rate. The US and Canada are doing the same.

Fiscal policy changes:
How quickly New Zealand’s current internal budget surpluses return to deficits all depends on how aggressive/successful the new Labour Coalition Government is in in implementing its spending plans. An abrupt change in an economy’s fiscal policy from “restrained” to “loose” is typically met with a tighter monetary policy stance to counter the inevitable inflationary impacts. How these fiscal/monetary policy inter-relationships play out over coming years in New Zealand will have a direct bearing on the timing and extent of interest rate increases.

Fuel price inflation:
Petrol pump prices are on the rise due to recent increases in crude oil prices and the sharply lower NZD/USD exchange rate. All internal and external freight costs also go up as these two prices are automatically adjusted into business freight rates.

The RBNZ’s dissemination of their inflation forecast miss this year should be including an analysis of what consumer prices are still reducing in the economy (only telecommunications) and what prices are rising and forecast to keep rising (all the rest!).

Whilst all the aforementioned are valid points for the future inflation outlook, I suspect the RBNZ under their interim Governor will play a “wait and see” approach with the new government, economic growth, inflation and thus monetary policy considerations i.e. not much change in the tone from the August MPS.

Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com