Figures out this week are expected to show our inflation at near 10-year highs - but the key unanswered question is whether inflation will dwindle of its own accord, or need a push from higher interest rates

It's probably been a good many years since inflation figures (the Consumers Price Index) have been as keenly anticipated as those to be released by Statistics New Zealand on Friday (July 16).

Inflation has been the forgotten ingredient in your life. Time was that you would buy a product one week, go to get the same thing the following week and find the price had gone up - and not by a bit, by a LOT.

Now, however, for many many years inflation has gone missing in action. To the point where countries and economies have actively been trying to generate inflation so as to prevent economies stagnating. 

The Reserve Bank (RBNZ) has an official target of maintaining inflation within a 1% to 3% band and it explicitly targets 2% as the level to be achieved.

In fact, since the 2010-11 spike in inflation caused by the last increase in Goods and Services Tax (peaking at 5.3% in mid-2011), we've seen annual inflation either hit or exceed 2% in just two quarters - March 2017 and March 2020, when I am surprised to remember now myself, it hit 2.5%.

We can say with a fair degree of confidence that the June quarter 2021 figure will come in higher than that and so will see inflation at its highest level in nearly 10 years.

But is this of itself necessarily hugely significant?

Well, it depends.

The key factor driving rising prices has been Covid-related disruptions to the global supply chains. 

One-offs?

Central banks around the world have chosen to take the view that the inflationary impacts of these disruptions will be essentially one-off in nature and that the wave of cost pressures we are now seeing will work its way through by the end of the year and all will be serene and non-inflationary again.

There are, however, plenty of economists and other market observers increasingly doubting that the inflationary impact will be quite so fleeting.

The big question to be posed by the June quarter inflation figures then - and one that we might not be able to answer straight away - is whether the higher inflation figure we are going to get sees us pushing to some high water mark of a short wave of inflationary pressure, or will it indicate a more persistent move higher?

That's obviously a pretty far-reaching question with huge ramifications.

At the moment the RBNZ still has our interest rate-setting Official Cash Rate at the emergency level of just 0.25% it was dropped to in March 2020 as the Covid crisis gripped. The RBNZ signalled in its May Monetary Policy Statement that it may begin to raise the OCR from the emergency levels in the second half of 2022.

Since then, however, every piece of economic data has come out way stronger than expected. Our economy is starting to run hot. And where heat goes, traditionally so goes inflation. But we do know that a lot of the traditional 'rules' of inflation have appeared not to apply any more.

This time could be different

Economists are starting to think though that this time could be different. And maybe this time the inflationary pressures will persist. That's why since the RBNZ first shocked the marketplace with its forecast of OCR rises in the second half of 2022 the market has run with the narrative to the extent that the four biggest banks are now all picking OCR rises from November THIS year. 

And they will all be looking for clues and steers from the inflation figures out on Friday. But will the figures tell us all we want to know? They'll probably tell us that inflation's up there now - but not whether it's going to stay there. However, doubtless our economists will be trying to get on top of what it all means and whether the inflationary red light is flashing for real.

As for what the economists are picking for the actual figures that come out on Friday - well big. That is, of course, big by the standards of inflation we've become accustomed to.

As at the March quarter, annual inflation stood at just 1.5%. However, the lockdown-affected June 2020 quarter, which saw a -0.5% drop, will come out of the latest annual figure, so the starting point for the annual inflation figure's actually considerably higher than 1.5% - I mean if you substituted that -0.5% quarterly figure for zero, annual inflation would be 2%. And the inflation figure for the June 2021 quarter will not be zero.

Significant contributors to inflation in the latest quarter are expected to be fuel prices, housing and household utilities and rising food prices.

Inflation at the top of the range

Economists are suggesting the quarterly inflation figure could be +0.8% or higher, giving an annual figure of 2.8%-3.0%. Of course, 3.0% would put it right at the top of the RBNZ's targeted range. Not a problem for the central bank if it still believes the rise will be temporary. But if inflation proves a bit more persistent than that, well bring on those interest rate rises.

ANZ economist Finn Robinson and senior economist Miles Workman in their preview of the latest inflation data say they think that consumer prices rose 0.9% in the June quarter, giving a 3.0%  year-on-year figure.

"As we’ve moved through 2021, transitory inflation pressures have started to look more persistent (although not necessarily permanent). And there are signs that some inflation pressures will be more sustained, especially with the labour market likely at (or close to) full employment," they say. 

"...The myriad of supply chain disruptions brought on by Covid-19 are showing no signs of easing any time soon. Shipping costs continue to increase, and delays at ports are making physical goods and materials more scarce (and therefore more expensive). There will inevitably be some payback from these cost increases (ie falling prices) – they are a symptom of the unique times we’re all living through after all. But this payback is looking like it’ll take a while to come around."

Robinson and Workman say with the labour market already within cooee of full employment, and the border still closed, they expect to see considerable wage pressures developing, starting in Q2 ("although we won’t know for sure until the labour market data are released on August 4").

They point out that rising costs in themselves will not fire up inflation - but there's increasing signs that firms are passing on these costs to customers.

Higher expectations

"All up, that speaks to higher inflation expectations, which means that higher inflation could become more embedded in price and wage setting behaviour. In fact, the ANZ Business Outlook suggests inflation expectations may be starting to get a tad too high to be comfortable for the RBNZ. Combining all these factors together, we’re looking at very strong inflation in Q2, and for the rest of the year. And without OCR hikes (which we think will start in November), it’s easy to see inflation starting to get a little out of hand."

Robinson and Workman point out that  "the drivers" of inflation matter.

"...The RBNZ isn’t going to hike interest rates just because oil prices went up a bunch. But as we discuss above, when we cut through the noise of higher oil prices, minimum wage hikes, base effects, and persistent supply disruptions, we are seeing signs of sustained underlying inflation pressure. The labour market is tight, businesses are passing on higher costs, and consumers are expecting strong price increases – that’s all a recipe for sustained inflation pressure."

Kiwibank economists note that New Zealand is currently in the middle "of an interesting experiment, of sorts".

"We have relied heavily on migrant labour. Migrant labour has filled many gaps, and put downward pressure on wage growth. Without the inflow of migrant workers, our labour force has tightened, quickly. And wage pressure is building as employers try to entice workers into their industries. Anecdotes suggest we are much closer to full employment than previously thought. And the other axis of the beloved Phillips curve is reacting to an array of pressures. Inflation, the original half of the RBNZ's dual mandate is rising," they say.

They are expecting "a 1% jump in prices" over the June quarter, pushing the annual rate "to a whopping 3%".

"From the Reserve Bank's latest round of forecasting, they're picking a 2.6% annual lift in prices- with considerable upward bias. Since May, the wave of cost increases firms are facing has grown significantly. Global supply chain disruptions are leading to higher freight costs, commodity prices are rising, and firms are finding it increasingly challenging to source both materials and staff. But with demand running hot, firms are able to pass on the rising costs. The NZIER's latest survey of business opinion is evidence that firms are doing just that. A net 39% of the firms surveyed hiked prices in the June quarter, and a net 52% expect to do so in the next quarter.

More sustained

"The RBNZ focusses on the medium-term. Cost-push inflation is typically looked through, given that it's usually temporary in nature. However, the current experience looks likely to be more sustained with supply disruptions ongoing and our border expected to remain shut until next year at the earliest. There's growing risk that long-term inflation expectations are re-adjusted, and some of the current price pressures become entrenched. The core inflation measures will be keenly interpreted for any clues on just how transitory these pressures are," the Kiwibank economists say.

Westpac senior economist Satish Ranchhod, who is picking +0.8% quarterly inflation and 2.9% for the annual figure notes that the Covid-related supply disruptions "have come atop of much stronger than expected demand conditions".

"The past few months have seen economic activity consistently surprising to the upside, with strength in retail spending, a resilient housing market and improving trading conditions for businesses across a range of sectors. This firmness in demand has given businesses greater leeway to pass on cost increases into the prices of consumer goods."

Ranchhod stresses that an important factor is what the latest inflation report and recent demand indicators signal for the coming quarters.

"The RBNZ has assumed annual inflation will peak in the June quarter, with modest increase further ahead. However, we think that the inflation outlook is stronger than the RBNZ has been assuming."

'Stuck above 2%'

ASB senior economist Mark Smith, who is picking a +0.8% quarterly rise and 2.8% annual inflation, but with "upside risk", says the annual inflation figure looks set to move above 3% over the second half of this year "and remain stuck well above 2% next year due to a combination of cost shocks and increasing capacity pressures".

"...Our research highlights that pressures on economy-wide capacity have become more widespread and look set to intensify over the next year or two. Capacity pressures are particularly intense in the labour market, with the economy effectively at (or close to) maximum sustainable employment, notwithstanding some residual weakness in some pockets. Combined with a solid, but uneven, pace of demand-side expansion this will push up medium-term inflation."