It might have felt like every inflation figure released for the past two years was a "crunch” one, but the September quarter figures due out in the coming week REALLY DO loom as a massive test of the Reserve Bank's credibility.
The Reserve Bank (RBNZ) is, remember, charged with keeping inflation as measured by the Consumers Price Index (CPI) within a 1% to 3% range, explicitly targeting 2%.
However, since the annual rate of inflation rocketed from 1.5% in the March quarter 2021 up to 3.3% in June 2021 it has been a long way outside of the target range - for well over two years now. The RBNZ has slammed us with high interest rates in order to take the heat out of the economy and inflation. Battle has been joined, but it is not yet definitively clear that the RBNZ is winning.
The CPI hit a 32-year high of 7.3% in June 2022 and has subsequently fallen only gradually. As of June 2023, the most recent figure, the annual rate was 6.0%.
If you look around the world, inflation has taken a lot longer to get under control than central banks and economists everywhere predicted. At every step of the way it has proven more stubborn than expected and hoped.
Just as an example of that, in its August 2022 Monetary Policy Statement, the RBNZ had forecast the annual rate of inflation would by June 2023 be down to 4.5%. Well, as stated above, the actual figure was 6.0%. And apologies to the RBNZ if it appears mean to pick that out, but I use it merely as an example. I'm sure if we looked back through all the forecasts made by various economists at the time we could some who missed the mark by even more.
I use the above example because economists' forecasts are now picking a relatively swift decline in the inflation rate over the next year.
So, eyes forward and on to the CPI for the September 2023 quarter due to be released on Tuesday, October 17.
We know in advance there's a few curly things to look out for in this one. The 25c fuel excise duty cut was reversed again at the end of June - so that will have an impact. And fuel prices have been surging again anyway. So, that will have an impact.
The RBNZ as of its August 2023 Monetary Policy Statement was forecasting the annual inflation figure will be 6.0%, IE exactly the same as it was in June.
I just had two major bank economists' final forecasts in front of me before completing this article (Westpac 5.8%, ANZ 6.1%) but these two picks do seem indicative of a general range of thinking among other economists of between about 5.8% and 6.1%.
Composition key
The next thing I'm going to say appears contrary. If the final figure comes out under 6% that's not necessarily 'good' news. Likewise if the figure comes out over 6% it's not necessarily 'bad' news.
I say this because whatever the 'headline' figure, it is the composition of it that will be the crucial thing.
The 'headline' CPI figure is made up of 'tradable' inflation imported from overseas (think fuel, for example) and 'non-tradable' domestically-generated inflation.
Through the Official Cash Rate, currently at 5.50%, the RBNZ essentially targets domestic inflation, since it can't do a whole lot about the price that has to be paid for imported goods such as fuel.
So, it is the domestic inflation that is vitally important - and that's what's looked particularly problematic of late.
According to the June 2023 CPI figures, at that time our 'non-tradable', domestic inflation annual rate was 6.6%, while the 'tradable', imported inflation was 5.2%.
In fact our annual rate of domestic inflation has now been at 6.3% or higher for five whole consecutive quarters. That's a problem. 'Sticky', the economists call it. Ingrained is perhaps another way to look at it.
The RBNZ is forecasting that domestic generated inflation will have dropped to an annual rate of 6.2% as of the September quarter.
If the RBNZ has a significant 'miss' on this, IE its forecast undershoots the actual domestic figure, then, trouble.
The September quarter is supposed to signal the beginning of a significant rate of decline in that domestically generated inflation, with the RBNZ forecasting that the non-tradable rate will fall rapidly to 5.5% by December 2023 and then, looking out a year, be down to 3.3% by September 2024.
Okay, so what if domestic inflation doesn't play ball?
Well, there's only one thing for it. The RBNZ would have to raise that OCR again. Mortgage rates would likely be on the way up again and the whole 'higher for longer' idea would start to develop into 'higher for EVEN longer'.
The next OCR review for the RBNZ on November 29 is the last one for for this year - and for three whole months. If domestic inflation is not looking under control when the RBNZ's Monetary Policy Committee sits down to deliberate on November 29, they will hike again. They will have to. A hike for Christmas. Surely, it would be too long to wait till late February.
So, what, numerically would be a 'bad outcome' for domestic inflation in those September quarter figures?
Well, the RBNZ's forecasting a 6.2% annual rate, down from 6.6%. Okay, so, if the actual figure came in at 6.3%, well, that would be moving in the right direction, the RBNZ can live with that. How about 6.4%? Not so good. In that case the RBNZ's decision whether to hike or not to hike would possibly hinge on the labour market figures being released on November 1. If it's 6.5% then definitely, I think, it's got to be an OCR hike. And 6.6% or worse? Well, disaster really.
But hey, let's all take some happy pills. If it is 6.2% or even lower then fabulous. Very pleasant surprise. We are on the right track. Very probably we can presume the OCR will stay 'on hold' for the foreseeable future.
Is it really all just about the domestic inflation figure though? Well, yes, pretty much - with one slight qualification. In terms of the 'tradable' imported inflation figure for the September quarter, the RBNZ is picking that it will have risen from the previous 5.2% to 5.8% and that's the reason why the 'headline' inflation rate is expected to stay at 6.0% as it was for the June quarter.
If the imported inflation figure does turn out far worse than expected and we see it blow out that headline inflation figure to above 6%, well, it's definitely not a good look for the RBNZ - but the central bank would be able to 'look through' the imported inflation elements in the overall figure and leave the OCR on hold. A major concern though would be if the country's price setters are spooked by that still very high 6%+ figure and start raising their prices again in reaction. That would be the dreaded 'inflationary expectations' starting again to fuel real inflation. But that's probably something the RBNZ would need to deal with in the New Year.
Anyway, the upshot is that much rides on these CPI figures. This is crunch time. We need to see signs that inflation is moderating. Otherwise the RBNZ will need a rethink. And a rethink would mean higher for longer interest rates.
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40 Comments
Nats really don't like Orr. With inflation still pumping he has caved to political pressure and held off raising the OCR again-his job. Would not be surprised if he is gassed quickly. But even a new appointment is faced with the same mess.
Inflation still pumping way above target level....
Domestic inflation (nontradable) is a joke - they haven't updated the methodology for 20 years. RBNZ opined on this in Feb 23 MPS statement - noting that domestic inflation has increasingly tracked imported inflation in recent years. Have a quick look at the component parts of domestic inflation that are most influential...
- Food - primarily a function of global food prices these days. Export prices determine domestic prices for our home-produced stuff and import prices do the rest.
- Domestic airfares - fuel makes up around a quarter of airline costs, and plane leasing / finance are big too. Yet, Stats NZ consider domestic airfares to be 100% determined onshore?!
- Rent and price of a newly built house - now, these are determined more onshore! But, will hiking rates moderate rent increases or reduce the costs of house building (errrm, finance)? See also Local Govt Rates, Insurance, Electricity, Broadband etc, which make up most of the rest of domestic CPI.
What is going on in the big wide world is that inflation in all advanced economies is tracking down slowly in unison - we are about midpack. A few countries have made more progress than others - Denmark Spain, France, Switzerland, etc, but the credit in all of those places goes to Govts that were prepared to intervene early to stop energy prices and profiteering from having a contagious effect on other prices.
What would we do without your valuable insight Jfoe.
My thinking is that the problem is deep in terms of how we actually understand and frame what inflation is. And the key people don't help. No better example of this was Paul Krugman's nonsense this week.
Paul Krugman was widely trolled on Thursday for saying that if you just ignore food, energy, housing, and used cars — unavoidable costs for many Americans — then the period of surging prices has passed.
"The war on inflation is over," he posted on X, attaching a chart showing the Consumer Price Index (CPI) dropped from 7% last summer to below 2% in September if you exclude those four items. "We won, at very little cost."
https://www.businessinsider.com/paul-krugman-inflation-chart-food-energ…
Lol. Economists. It would appear the mainstream orthodox and the banks' mouthpieces are experts in the academic theory and completely disconnected from reality. Glorified statisticians at best fitting the data into their models and unable to view it objectively from their ivory towers?
Damn, Upton Sinclair's quote gets a good workout.
Maybe instead of burning witches at the stake it should be the false prophets...
Both of which are paid for with government debt, probably at a horrendous cost. That money is going into the economy and therefore increasing inflation (expansion of the money supply). I would hate to think how much the thousands of road cones seemingly in every street are costing!
Good thoughts, David.
A couple of mine.
1. using annual inflation figures - that obviously include quarters where inflation was higher - may not tell the full story. I will be looking closely at this quarter and whether quarterly rates are falling from the peak quarter.
2. tradable inflation figures need to be looked at closely. Even when we are buying stuff offshore, the price of which we have no control over, there is considerable local 'ticket clipping' that contributes to local inflation. E.g. oil is often cited but local companies clip the ticket before it is consumed; and they have not been adverse to jumping on the inflationary band wagon to pad their margins.
3. covid "buffers" had been built up prior to the RBNZ finally realising they'd got things completely and tragically wrong with their massive monetary stimulus. In time, we'll be able to calculate how long these buffers lasted before people finally realised they were going to be in trouble. My guess is this added about six month to the time it took before the higher OCR started to have an effect. Add six months to the timeline and this time isn't much different to previous RB actions.
4. Raise now vs. raise after Christmas? If it is necessary to raise (I'm not in that camp), the best time is after Christmas when the effects of previous rises has become clear. We already know retail and manufacturing and construction are struggling, if not in real trouble. While many commentators here would like to see a complete collapse, I'm more of the view causing such pain is unethical and just plain nasty - and is unnecessary - and would be yet another example that the RBNZ's MPC needs replacing.
5. putting too much faith in bank economists. Never forget that they are paid employees of the banks they work for and to believe their analysis isn't worded and constructed to further the interests of their bank is a mistake.
...central bank would be able to 'look through' the imported inflation elements in the overall figure...
This argument always seems to get rolled out when we are importing inflation and never when we are importing deflation. No one's was arguing ten years ago rates should be raised because core inflation was meeting target.
RBNZs inflation mandate is to maintain low and stable inflation, not partial price stability. We chose CPI as our inflation measure for that reason, it was the measure that was important to people. Headline inflation must come down even if that means having 0% domestic inflation.
How much do natural gas prices influence our inflation though? We don't use gas for heating or electricity generation anywhere near as much as Europe or the US
Any oil extraction would be tiny and not move the needle on the global oil price.
So perhaps some effect, but I can't see it being significant
Correct. There is no other option than raising rates now. Not doing so will see the NZD decreasing and inflation ramping up. The OCR should have been at least 6% by now. A raise next month by at least 25bps is absolutely necessary.
The sooner this new Government removes the employment clause from the RBNZ's mandate (as they have promised), the better, as this will leave Orr no excuse for not raising rates as required.
Very close to the real situation, 2024 will see the supply/demand equation assert itself much to the horror of those spruikers who deny its existence - AKA as Real Estate agents, Bank Economists and stoopid politicans. Its happening in China already but of course its different in NZ, it always is until it isn't.
We sell consumer goods into large retail chains. Can tell you the foot traffic and sales have been trending way way down for ~6 months. Top of the market is still in (people with money) however middle class are not buying household goods. Sales in one of the big chains is down 20%+ YOY. Although cafes etc seem to be holding up, it’s genuinely a grim recessionary environment in my industry.
This is a bit like the post by Paul Krugman that went viral on X recently where it was difficult to tell if he was being sarcastic when he said that inflation had been tamed without any pain when you remove everything from the index that you actually need to buy on a daily basis in order to survive.
The more I look at the US 10 year, the more I think we've just ended a 40 year cycle of falling rates and may now be moving into a period of 40 years of high/higher rates.
US short term/cash rates could be 6-7% in a sustained fashion, and may mean we see interest rates of 10% here in the longer term (I don't have a specific timeframe).
Demographics and recent fiscal/monetary policy look very inflationary to me - and any attempts to avoid pain, will only make the inflationary pain worse (e.g. if central banks start printing more money).
https://fred.stlouisfed.org/series/DGS10
The world changed in 2020 - just as it did in the 1970's when the boomer generation become the dominant force in society. If the '4th turning' theory is correct, we are now going to see the fall of the boomer generation and the rise of the millennial generation who see the world in the opposite fashion of their boomer parents.
On what planet is a 6.2% domestic inflation rate considered "fabulous"? Domestic inflation has been over 6% for almost two years now, and any 0.1% point moves are rather meaningless. Perhaps we should acknowledge the obvious - its simply not shifting. Compare overseas inflation rates where inflation has been brought back to 3% this year after being 6-7% last year. Why can they do it and we can't?
Mar 22 6.0%
Jun 22 6.3%
Sep 22 6.6%
Dec 22 6.6%
Mar 23 6.8%
Jun 23 6.6%
Sep 23 6.2%???
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