There's a "very real" chance the Reserve Bank (RBNZ) will continue to be surprised on the "upside" by domestically sourced inflation, BNZ economists say.
In BNZ's latest Markets Outlook publication, head of research Stephen Toplis says he hopes the RBNZ will "eventually accept that there are a number of relative price increases such as insurance and rates that can be looked through".
"Nonetheless, it has been made abundantly clear that more progress needs to be made on this [domestic inflation] front."
Annual inflation, as measured by the Consumers Price Index (CPI) was 4.0% as of the March quarter, down from a peak level of 7.3% in mid-2022. However, much of the fall has been driven by so-called 'tradable', or imported, inflation, while 'non-tradable' or domestically sourced inflation has been what the economists like to call 'sticky'. It fell only to 5.8% in March, from 5.9% as of December - when the RBNZ had forecast it would fall to 5.3%.
The RBNZ, which is forecasting that the 'headline' overall inflation figure will get back into its targeted 1% to 3% range by the end of this year (it forecasts 2.9%), is picking annual non-tradable inflation to be 4.7% by the end of 2024.
"We will be monitoring this very closely," Toplis says, "but fear it could be as late as next year before annual non-tradables inflation falls below 5.0%."
The CPI inflation figures for the June quarter are due to be released on July 17. Before that, however, on July 10, the RBNZ will be having its next review of the Official Cash Rate, which has now been 'on hold' at 5.5% since May 2023. (interest.co.nz will do a full preview of the OCR decision closer to the time.)
Toplis is expecting no change to the OCR in next week's decision and thinks the RBNZ will "stick to its knitting".
"It will likely acknowledge that economic activity is faltering but continue to warn that it is in no rush to respond to that," he said.
Financial markets are currently fully pricing-in a cut to the OCR in November 2024 - but the RBNZ's not forecasting changes till the second half of NEXT year.
"We too believe rate cuts will eventually occur sooner than the Q4 2025 indicated in the [RBNZ's] May Monetary Policy Statement," Toplis said.
"But while we understand that markets, focused on the demise of the economy, want action now we, equally, stress that it remains inflation that is the focus of the central bank and it, rightly or wrongly, has been giving a clear message that there is much work to be done on this front."
OCR clarity by November
Nevertheless Toplis does believe the RBNZ will be in a position by the time of its November OCR review to "give clear updated guidance as to the easing track ahead".
"We still don’t think the RBNZ will ease in November but will instead set things up for a first move in February."
Toplis said there are two "necessary" developments that need to occur before the RBNZ lowers the OCR, along with a series of "desired" outcomes that also need to occur.
In the 'necessary' category is getting headline CPI inflation back under 3%.
"We are forecasting annual inflation will still be 3.5% in the June quarter. However, we are angling for it to be 2.8% in the September quarter. At the May MPS the RBNZ was forecasting 3.0%. The September CPI is published on October 16. If our forecast proves correct, then this potentially makes the November Monetary Policy Meeting live for a rate change.
"We think a secondary necessary condition is that the [US] Fed has begun easing. The Fed easing in and of itself doesn’t mean the RBNZ needs to follow suit but if the Fed moves it (a) suggests weakness in the US economy which will dampen global demand and (b) might help support the NZD [kiwi dollar] on an interest rate differential basis."
Other key factors to take into consideration Toplis said are: non-tradable inflation, fiscal policy, and productivity.
Toplis said on the fiscal policy front, the RBNZ will want to feel more confident fiscal policy is not only not adding to inflation but countering it.
"This will require some satisfaction the negative fiscal impulse the Government is forecasting can be achieved."
Higher than expected unemployment 'will be a driver' of OCR cuts
He said the productivity issue is a difficult one and he thinks perhaps the unemployment rate becomes "a good near term proxy" for likely shifts in productivity.
"Given this we think a weaker than expected labour market will also eventually be a driver of the Bank’s decision to ease earlier than it currently assumes. But it might take a while for the Bank to reach this conclusion," Toplis said.
Unemployment was 4.3% and rising as of the March quarter. The RBNZ is forecasting unemployment to hit 5.0% by the end of 2024 and peak at 5.1% in June of next year.
BNZ economists are picking that unemployment will rise faster and further. They think unemployment will be 5.3% by the end of this year and will peak at 5.5% in the March quarter of 2025.
Toplis noted that the RBNZ "already has a steep rise in the unemployment rate built into its near-term forecasts". However...
"We think the surprise will be that the increase continues unabated rather than the unemployment rate peaking at the 5.1% the RBNZ currently assumes," Toplis said.
"The data are not likely to seriously surprise the Bank for several quarters but its forecasts could well change earlier based on the ongoing deterioration in the economy."
28 Comments
In BNZ's latest Markets Outlook publication, head of research Stephen Toplis says he hopes the RBNZ will "eventually accept that there are a number of relative price increases such as insurance and rates that can be looked through".
Seems to me that rates and insurance may be double inflation rate for years to come.... councils are failing to even maintain existing infrastructure within budget.
PDK - it seems that we are at the limits....
What's next, include house prices in the mix since they're falling?
Anything to paint interest rates as the villain instead of the debt the banks were only too happy to create.
PDK might have been a decade or two early, but what a privilege to have been told ahead of time eh. What to do, what to do.
The system's going to give most diminishing returns till it goes bang, this much should be evident.
The real question is how many kicks of the can are left, for how long.
The what to do could be:
- hope you're at the top of the pile of the status quo
- abandon your city before the mass exodus, secure land with the ability to provide most of your core needs, and shield yourself from inflation
The RBNZ can look through one off events (which makes sense). In this case you could argue some of the insurance and rates inflation is a result of the flooding last year. Whether that flooding is a one-off event or a continuous result of climate change is debatable.
"Toplis says, "but fear it could be as late as next year before annual non-tradables inflation falls below 5.0%."
That's not the Fear! Fear is that it pushes on, back to 7% and above. "Not going to happen!" I hear the cry. Which is pretty much what was said in late 2021 - that an OCR of 0.25% would be in vogue for a couple of years to come. And yet, a year later it was 3% and heading north - for all the same unexpected reasons that we refuse to see today. ie: "Let's just keep looking-through and ignoring the inconvenient stats, shall we?"
It can be a relatively important distinction to make.
Many posters here may not believe in the Phillips curve, but many central banks seem to (and whether we should is another conversation for another day).
If other central banks are going through a similar period of inflation and are trying to get it under control, it's probably worth noting that there is only so far they will go - they're not going to keep pushing past that 2% mid-point target that many of them do have, and risk driving unemployment substantially higher than it needs to be, just to help us out.
A substantial chunk of our inflation comes from non-tradeables, and there is likely a limit on how low we can expect tradeables inflation to go (though I guess we may go back to the good old days of running non-tradeables substantially above 3% while important deflation from China). It could be pretty problematic to just assume the recent progress on inflation will carry on as is whilst we leave non-tradeables inflation running at 5.7%.
And how do we combat domestic inflation? We'd all like to see some action on the banking, supermarket, petrol sectors and more (building materials perhaps) to prevent oligopolistic pricing behaviours of which we are so well known for in NZ. Until this is addressed, we as the consumer have no other power than not purchasing, of which we can't avoid when it comes to food, fuel to some degree, and mortgage for those who already have one.
There is an amount of inflation that is practically unavoidable and trying on control it with the CPI is like trying to make ice in the microwave. Insurance premiums increasing due to climate change is one example. The CPI controls demand and stops prices going up when supply is restricted. If supply isn’t constrained then reducing demand can have the opposite effect as they are the business is selling less but still has overheads to pay etc.
Rates should not be included in the cpi calculation. It is effectively a tax. Councils can and do decide to add services or remove services which affects the rates they charge. Auckland is getting an increase to rates to pay for rubbish collection instead of pay as you throw. This will look like rates going up but will be offset somewhat by not needing to buy rubbish tags . Inflation is the erosion of the buying power of money not how you pay for the goods/services. Insurance shouldn’t be considered either as premiums are based on estimated risk (claims) + cost of service + a margin. If claim frequency goes up and everything else stays the same premiums will increase but the cost of fixing a cars bumper etc is unchanged. The cost of repairs/replacement is already in the CPI.
My favourite comment from the last RBNZ release was when they said that falling labour productivity was a key reason for keeping interest rates high. The theory is that falling labour productivity reduces economy capacity, which pushes on inflatio. Obviously, in the minds of brainwashed economists inflation is always the result of demand exceeding economic capacity.
The flaming fools might have missed that labour productivity is measured by basically dividing profits by hours worked. So, when the economy slows down because RBNZ is destroying disposable income, profits fall quickly, and this quickly reduces labour productivity!
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