David Hargreaves has a look at what the March quarter inflation figures might bring. That's the easy bit. The hard bit is trying to work out what might come next

Now is one of those unfortunate times when the various pieces of economic data appear to be heading in different and confusing directions.

The Trump tariffs are proving a huge distraction. It's impossible to confidently quantify what the ultimate impact of these will be. They could become a major spanner in the works. Equally, this time next week the rules of the game could have changed and by that time we will all be worried about something else. That's the 'climate' we are operating in with this US administration. 

What we can say is that the outlook for all things economic has become extremely cloudy. And that's certainly true of inflation. What happens now? Is inflation going to go up? Is inflation going to go down - and even drop below the levels that we target? How can anybody really forecast anything at the moment with any degree of confidence?

It's in the middle of all this turmoil that our inflation figures for the March quarter, as measured by the Consumers Price Index (CPI), are being released on Thursday, April 17. One thing to watch out for in these new figures is that they incorporate changes to the basket of goods Statistics New Zealand monitors.

The Reserve Bank (RBNZ) in its most recent (February) Monetary Policy Statement (MPS) forecast that our annual rate of inflation was likely to increase to 2.4% from 2.2% as of the December quarter. It forecast a quarterly increase of 0.8%.

And the RBNZ said this, along with those February forecasts:   

"Consumer price inflation in New Zealand is expected to be volatile in the near term, due to a lower exchange rate and higher petrol prices. The net effect of future changes in trade policy on inflation in New Zealand is currently unclear. Nevertheless, the [RBNZ Monetary Policy] Committee is well placed to maintain price stability over the medium term. Having consumer price inflation close to the middle of its target band puts the Committee in the best position to respond to future inflationary shocks."

The RBNZ forecast that inflation could peak at 2.7% in the September quarter this year.

Remember, the RBNZ is charged with keeping inflation between 1% and 3% and it explicitly targets 2%.

A quick recap: As we know, inflation charged upwards in the wake of the pandemic, hitting a high of 7.3% in mid 2022. The RBNZ responded to this by hiking the OCR all the way up from the pandemic emergency setting of 0.25% to a cycle peak of 5.5%.

Dampening the fires

Well, it took a while to dampen the inflation fires, but the RBNZ decided things were sufficiently under control to begin dropping the OCR again in August last year. Inflation duly dropped back under the 3% mark in the September quarter of last year, to 2.2%.

And while the level of inflation has been forecast to rise this year, no forecasters are expecting it to rise above 3% again.

In terms of what happened in the March quarter, I didn't have economists' previews in front of me at the time of writing this, but the general murmurings coming from major bank economists in the lead up to the release of these inflation figures is are in agreement with the RBNZ's pick of 2.4% annual inflation.

A figure of 2.4% sees inflation above the 2.0% that the RBNZ explicitly targets. However, there's two parts to the story. The RBNZ is most concerned about domestically sourced inflation. That's the thing it has some control over. And domestic inflation is expected to keep easing. 

The RBNZ can't, however, do much about overseas sourced inflation. And the extremely volatile global conditions currently in play complicate matters, opening up the possibility of lumpy, overseas-generated inflation. The central bank will, as much as possible attempt to 'look through' short term spikes in offshore generated inflation. 

In reasonably simplistic terms, the tariff situation could see short term inflation spike, but longer term - so the economists reckon anyway - the impacts globally could actually be disinflationary. The other possibility though is stagflation - the ultimate toxic mix of low growth, high unemployment and rising prices.

BNZ head of research Stephen Toplis nicely summed up matters in his review of the RBNZ's OCR decision on April 9 - bearing in mind that these comments were made before the US administration's 90-day pause announcement.

"It is apparent to all that the current tariff fiasco is bad news for growth. And even if all the stupidity of the last few days was reversed tomorrow the remaining uncertainty would still have a negative effect on output, Toplis said.

"What is far less certain is what the impact on inflation will be, both here and abroad. In short, will the negative growth impact weigh on prices more than the tariffs and productivity losses push inflation higher? And even if prices rise will this be permanent or temporary? And last but not least, if we get stagflation will central banks be able to hold their mettle and stick doggedly to their inflation-fighting dogma?"

For the record, I thought the RBNZ in its statement accompanying the decision to cut the OCR this week to 3.50% from 3.75% achieved a nice balancing act in a difficult situation.

It said this:

The recently announced increases in global trade barriers weaken the outlook for global economic activity. On balance, these developments create downside risks to the outlook for economic activity and inflation in New Zealand.

Having consumer price inflation close to the middle of its target band puts the Committee in the best position to respond to developments. As the extent and effect of tariff policies become clearer, the Committee has scope to lower the OCR further as appropriate. Future policy decisions will be determined by the outlook for inflationary pressure over the medium term. 

So, what that tells me is that the RBNZ's going to react to what is in front of it - and it will be guided by what inflation is doing before taking action.

It is worth noting that there was no mention this week of the explicit promise made by then RBNZ Governor Adrian Orr in February that after a 25 point cut in April the OCR would then also be cut at the May 28 OCR review. The RBNZ has left its options completely open. This doesn't mean it won't cut in May. But it's not committed to it.

The race to go low

Meanwhile, at time of writing (and this is VERY volatile and changing a lot every day) the financial markets were pricing in a good chance that the OCR would be 2.5% by October. Just a week earlier a low point of a little above 3.0% was being priced in. 

All very interesting. But what indications have we had so far this year about what inflation is actually doing?

Well, Statistics NZ's monthly Selected Price Indexes, which cover about 45% of what's in the Consumers Price Index, have been a notable addition to our regular economic data - particularly as they cover some of the more volatile elements in the CPI. We are now getting a much more timely reading on what inflation's doing.

The figures for January and February were a bit of a mixed bag - particularly regarding food prices, which rose strongly in January.

ANZ's Business Outlook Survey for March showed a 'disconcerting lift' in inflation indicators. However, the long-running NZIER Quarterly Survey of Business Opinion - closely followed by the RBNZ - while, echoing the ANZ survey's recording of a lift in cost pressures for business, also showed that firms are currently seeing themselves as having limited power to pass on price increases.

If that remains the case then it's unlikely we would see a revival of the dreaded inflation expectations.

What it all adds up to is that while the coming week's March quarter CPI figures are probably going to show an uptick in inflation, it won't be a big one and it probably won't last.

But really, in such a fast-moving and volatile global climate, it's hard to make predictions and draw conclusions about what will happen. And second-guessing would be risky.

Since August 2024 the OCR has already been chopped by 200 basis points. That's a heck of a lot, but the impact of it will take time to feed through. We need to see what the full impact is of the cuts already made. The RBNZ seems intent on letting the data tell it what to do. And that seems the sensible approach in such a turbulent environment.

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