Inflation risks starting to elevate

By Roger J Kerr

Two pieces of economic news last week support my view that the export-led recovery in the NZ economy is already well underway; unfortunately the slow and patchy recovery in the domestic economy is still clouding many judgements about our current and future economic performance.

The monthly National Bank business confidence survey bounced back up in April following the earthquake-related falls the previous month.

Employments, profit, investment and export intentions were all up and this suggests GDP growth above +2% this year. Not spectacular, however well above the flat economy the doomsayers have been predicting.

There is no question that the negative impact of the Christchurch earthquake on the overall economy is turning out to be much less than expectations. Businesses in the Christchurch CBD (tourism and small engineering mainly) have certainly got it very tough; however the regional economy varies on with export activity nearly at full capacity. The Christchurch rebuild over the next few years still stands to add considerably to GDP growth and well as inflation (building costs).

The March import/export merchandise trade figures released on Friday confirm the major boost to the economy from the record high export commodity prices.

The monthly surplus would have been over $700m had it not been for a one-off $270m aircraft import.

Exports were a record $4.5 billion in the month. There is also evidence from the import figures that export industries are investing in new plant and machinery as the high prices encourage firm’s to increase production. I would expect that the annual trade surplus to steadily increase this year, which is a major turnaround from the continuous deficits over the last 15 years.

However, a word of caution on the export prices is that Chinese manufacturing growth slowed last month as their tightening of monetary policy starts to have an impact. The Chinese manufacturing PMI (“Purchasing Managers Index”) decreased to 52.9 in April from 53.4 in March.  Prior forecasts were for an increase to 54.0. Further negative China news like this has the potential to reverse the steep climb in commodities prices seen in recent months.

The chart below reveals that the rising CRB Commodities Index has caught up with the higher Chinese PMI since the GFC. However, can the commodity prices keep rising against a declining Chinese manufacturing growth?

The saviour for the NZ economy is that the floating NZ dollar will come down from the lofty heights above 0.8000 as commodity prices pull back.

Add these two positive economic indicators on to the increasing likelihood of wage claims and settlements above 3.00% over the next 12 months as workers seek compensation from significant increases in household costs. Many industries have not increased wages since the GFC hit in 2009 and there is a considerable catch-up brewing as food, energy and several other price rises drive the push for wage increases.

What all this means for interest rates is that the economy is already showing signs of doing better in 2011 than many expected after the earthquake and GDP growth in 2012 is still forecast to be over 4%.

The net result is higher inflation risks from the stronger growth and higher wages costs by business firms being recouped in price increases.

The inflation outlook is nowhere near as sanguine as many economic forecasters would want you to believe.