Prices up 1.3% in September quarter; more than expected; triggers early rate hike talk (Update 4, corrected)

Prices rose by 1.3% in the September quarter, the latest Consumer Price Index (CPI) figures showed. The rise was more than the 1.1% 0.8% rise the market was expecting and will encourage those picking that the Reserve Bank of New Zealand will hike the Official Cash Rate earlier than the latter part of 2010, as it has previously indicated. (Update 4 includes Westpac economist comment.) Annual CPI inflation was 1.7% in the September quarter, above the 1.1% the market was expecting. The annual increase was the lowest in five and a half years, Statistics New Zealand said. The 1.3% quarterly increase followed a 0.6% increase in the June quarter, a 0.3% increase in March and a 0.5% fall in the December quarter last year. In September 2008 quarterly inflation was 1.5% while annual inflation was 5.1%. The higher than expected CPI figures spurred the New Zealand dollar, which rose by around half a US cent on the news. Here are Stats NZ's comments on the figures:

"A big contributor to the lower annual increase came from petrol prices and airfares falling during the year, which partly offset higher prices for food, electricity, and local authority rates," Mr Pike said. Transport prices fell 5.5 percent during the year with lower prices for petrol (down 19.0 percent), international air transport (down 15.1 percent), and diesel (down 38.8 percent). Petrol and diesel prices peaked in July last year. In the year to the September 2009 quarter, food prices increased 5.4 percent, accounting for well over half of the CPI annual increase of 1.7 percent. Electricity prices rose 4.5 percent and local authority rates rose 6.6 percent. The annual increase in the CPI included a rise of 1.3 percent for the September 2009 quarter. "The increase in the September 2009 quarter was driven by higher food prices and international airfares, and by levy, excise and tax increases that usually occur at this time of year," Mr Pike said. Food prices rose 1.7 percent in the September 2009 quarter, driven by higher vegetable prices. International air transport was up 11.0 percent in the same period, rising from historically low levels in the June 2009 quarter. Vehicle relicensing fees rose 16.2 percent (reflecting an increase in the ACC levy), local authority rates rose 5.6 percent, and alcoholic beverages rose 2.5 percent (with higher excise duty from July).

The lift in inflation will be an unpleasant surprise for the RBNZ, though the mitigating factor is housing remains subdued. However, further "˜administrated inflation' in the form of additional ACC and medical charges can't be ruled out, and a series of "˜one-offs' will make the background inflation picture that much higher. It still appears that some disinflation pressure will continue from housing and wage costs. However, a lot of the downside risk to inflation has diminished, particularly the likelihood of inflation falling below the 1% inflation target floor. We see the inflation outcome and recent strengthening in house price increases as making the RBNZ more reluctant to leave substantial stimulus in place for a prolonged period. The risk has grown of the RBNZ unwinding the stimulus earlier than it implies. Since the September Monetary Policy Statement we have been saying a June start to the tightening cycle with risk of it being April. We now see April as the more likely timing.

While CPI inflation remains well within the RBNZ's target band, the higher than expected starting point and the fact the economy now appears to be building forward momentum is something that won't go unnoticed by the RBNZ. Today's data will no doubt continue to underpin the market's current view towards an earlier tightening cycle. This is now a risk that must be acknowledged and sees the bias look towards the first interest rate hike coming earlier than the September 2010 start we had initially envisaged. At this stage, we see little point tweaking between June and September. If there is a big call to be made it is for a March 50 basis points start. At this juncture we simply believe there is too much water to flow under the bridge before that potential becomes reality.

The genuine and underlying nature of today's inflation surprise has implications for medium term inflation and hence the future track for interest rates. For the RBNZ, the 0.5% surprise on annual headline inflation and the 0.2% surprise on annual non-tradeable inflation will be material. That is certainly the view of the market judging by the approximately 20bps lift in short term wholesale interest rates following the release. The RBNZ's expectation that the OCR will be at or below its current 2.5% level until the latter part of 2010 looks increasingly unrealistic. Upside surprises in activity (Q2 GDP) and now inflation suggest that the RBNZ will alter that expectation at the October OCR review. We are reviewing our mid-2010 call for the first hike in the OCR, with a view to bringing it forward. That said, market pricing for a hike by January feels a little too early.