High winter electricity prices keep producers' input costs up (Update 1)

New Zealand producers' input prices stopped falling in the June quarter, with prices the same as in the March quarter, Statistics New Zealand's (Stats NZ) Producer Price Index (PPI) showed. However, producers' output prices fell 0.7% over the quarter, largely due to lower prices for NZ dairy exports, Stats NZ said. (Update 1 includes economist comment.) High electricity prices during winter kept the overall prices of inputs from falling, while overall output prices were held up by higher costs for financial services. This implies business profit margins are being squeezed and inflation for consumers is likely to remain subdued as businesses are reluctant to hike prices during a recession. "The dairy product manufacturing index (down 19.9 percent) made the largest downward contribution to the outputs index in the latest quarter. Lower prices for exported dairy products, such as whole milk powder, cheese, and butter were the main drivers of this fall," Stats NZ said. This followed a 24.3% fall in the dairy product index in March and a 19.2% rise in December. "The major offsetting effect on output prices in the latest quarter came from the finance index (up 13.2 percent), following rises of 14.6 percent and 10.0 percent in the March 2009 and the December 2008 quarters, respectively. The latest quarterly increase was mainly driven by an increase in the financial intermediation charges index," Stats NZ said. The inputs index stayed the same in June from the previous quarter, following falls of 2.5% in March and 2.2% in December. "Within the inputs index, the sheet and fabricated metal product manufacturing index (down 6.7 percent) made the most significant downward contribution. Lower prices for raw materials, the appreciation of the New Zealand dollar and lower demand due to worsening economic conditions, were cited as the main drivers of this fall," Stats NZ said. "Electricity generation and supply made upward contributions to both outputs (up 11.0 percent) and inputs (up 10.4 percent) indexes in the latest quarter. Higher spot market prices in the winter season were cited as the main reason for the price increases, while higher prices for natural gas, which is used in the generation of electricity, also contributed to the increase in the inputs price index." The rise in electricity prices followed falls of 1.5% in the March quarter and 32.3% in the December quarter. However, Stats NZ said that despite the latest quarterly rise, in the year to the June 2009 quarter the electricity generation and supply index (inputs) fell 49.5%, which was its largest annual fall since the series began in 1994. JP Morgan economist Ben Jarman said the results would add to the concerns of Reserve Bank Governor Alan Bollard, who had become increasingly restless due to the stubbornly elevated New Zealand dollar.

Energy price inflation effectively has eliminated the positive effect of currency appreciation via cheaper prices for imported inputs. This leaves only the negative consequence of dampening domestic exports, just as the pick-up in global trade flows is on the horizon. The Governor has attempted to influence this dynamic in recent weeks by emphasizing that domestic economic conditions remain weak, and that interest rates will be low for some time. The discernible divergence in language with the relatively hawkish RBA should achieve the desired downward pressure on NZD; on our forecasts the RBNZ will begin tightening five months after the RBA, in July 2010.