Opinion: Inflation is a non-issue and the RBNZ can wait to hike the OCR

By Roger J Kerr It never ceases to amaze me that bank economists in New Zealand today continue to prattle on about the inflation risks stemming from retail spending activity as if there is an automatic correlation and direct cause/effect relationship from consumer spending to inflation. They do not seem to care about the irrefutable evidence over the last seven years in the New Zealand economy that strong consumer demand has not led to the inflation we have experienced. Never let the facts get in the way of the purist economic theory, which supposedly gets the bank's name in the business media as some kind of authority on inflation and thus the timing of the next OCR change. Increases in consumer confidence last week from the ANZ/Roy Morgan and MasterCard surveys had the economic gurus straight away extrapolating such results to strong future growth in retail spending, thus elevated inflation risks and a bringing forward of the commencement of OCR increases from June to April. We have not seen any "demand-push" inflation in New Zealand as these economists suggest since the mid 1990's, so I doubt that this type of inflation is suddenly going to re-emerge over coming months. The bank economic forecasters will be proven wrong on the OCR timing yet again, but they rely on the fact that most readers forget about bank forecasts for interest rates and currencies the day after they are made. In my view, inflation risks took a massive hit downwards last week from the double-howitzer blasts of:- - Non-tradable (domestic prices unrelated to import/FX rates) inflation moving sharply lower as the previous troublesome areas of electricity, local body rates and Government related health/education prices all finally moderating. - The Key/English Government being likely to make changes with the taxation of investment rental properties in this May's budget. Net result is that the frothy end of speculative property investing in an almost tax-free environment is coming to an end. The residential housing market activity has slowed right off of late and the RBNZ should not have any concerns about general inflation coming from this source in 2010. As the chart below of inflation sources in NZ depicts, supply-side food and energy prices (which we cannot control) have caused most of the inflation increases above the 3.00% limit since 2003. Inflation from the "Non-Competitive" (health, education, recreation, electricity, rates) sources has declined steadily from 4.00% in 2007 to 2.00% today. It is no coincidence that these price pressures have abated since the economic recession started in late 2007 and the change of Government in late 2008. The appreciation of the NZ dollar exchange rate in 2009 should work through to lower "Competitive" inflation sources this year (i.e. lower prices on imported goods). The eco-intelligentsia is also wrong to get excited about the inflation risks from the suddenly higher capacity utilisation measures. I do not trust these capacity figures from the NZIER survey one iota, they jump around far too much from one quarter to the next to have any confidence as to their accuracy. The RBNZ need not be in any hurry to lift the OCR this year as such a move would only stop NZ dollar depreciation the economy so desperately needs. The real market price of money away from the OCR interest rate settings of the RBNZ are up at 4.50%-5.00% anyway with banks paying these levels for term retail deposits and term wholesale swap rates are above these levels already. The OCR level currently is quite irrelevant to general monetary conditions and where investors and borrowers receive and pay their interest. I am confident the RBNZ understand this market situation; however the ill-considered wording change in the December MPS does make you wonder. Expect a bland, non-committed statement from the Governor with this Thursday's OCR review and no great reaction either way in interest rate markets. "”"”"”"”"”- * Roger J Kerr runs Asia Pacific Risk Management. 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