New Zealand's rate of inflation could get "stuck" above the targeted 1% to 3% if services-sector price rises don't slow down, according to ANZ economists.
In an NZ Insight publication titled 'Inflation Rotation', ANZ economist Finn Robinson and chief economist Sharon Zollner note that New Zealand is following a global trend of "the inflation pulse rotating away from goods and towards sticky services prices".
They say services prices are now contributing more than 2-percentage-points to our annual CPI inflation (which was 7.2% as of the December quarter), "and are showing no signs of slowing".
"Should that continue, we could see CPI inflation get ‘stuck’ above the RBNZ’s [Reserve Bank] 1-3% target band, even if goods inflation returns to historically average levels.
"...Combine a sticky services inflation pulse, with the risk of stubbornly high goods inflation due to the cyclone [Cyclone Gabrielle] or a renewed round of global goods inflation, and it’s worryingly easy to imagine overall CPI inflation remaining above the RBNZ’s 1-3% target range over the next few years."
The economists say the "relentless upside surprises" of inflation in 2021 and 2022 are "hopefully over".
"But it’s a long journey from 7.2% inflation back to the 2% midpoint of the RBNZ’s target band. And there are already significant bumps in that road. All of this points to the risk that interest rates will remain high for longer than markets currently anticipate. We therefore continue to expect the RBNZ will hike the OCR to a peak of 5.25% by May 2023, before holding rates at this level until at least the end of 2024."
The RBNZ itself is still forecasting a peak for the OCR (currently at 4.75%) of 5.5% towards the end of this year.
Robinson and Zollner note that central banks globally are "entering a new stage of the hiking cycle". Having rapidly lifted rates to a level that is broadly considered to be "contractionary", many central banks have slowed the pace, as they enter the ‘fine tuning’ stage, as opposed to ‘urgent catch-up’.
"But it remains highly uncertain how high interest rates need to be (and for how long) to ensure inflation returns to target. Goods disinflation is real, but for services inflation to fade, we need to see a realignment of labour demand with supply. This inflation rotation into services and away from goods will set the scene for monetary policy around the world as 2023 unfolds," they say.
Mirroring the global picture, goods inflation in New Zealand has peaked, but services inflation, has continued to build, they say.
"This really highlights the risk that even as the global inflation pulse starts to fade, domestically generated inflation and our super-tight labour market will keep the pressure on the RBNZ to remain tough on inflation."
So, why might services inflation remain stubbornly high? Robinson and Zollner say one reason could be if the domestic labour market remains hot.
"The interplay between services and wage inflation means that for this component of inflation to ease, we need to see demand and supply in the labour market become better aligned. Until this happens, we run the risk of seeing inflation remaining too high over the medium term (even if it eases from current levels)."
The economists say that until recently it was looking like the gap between labour demand and labour supply was starting to close. But labour market indicators over January and February 2023 point to the labour market "getting something of a second wind".
The "spectacular increase" in net migration in recent months does, however, point to an improvement in the availability of workers, which should ease some of the logjam in the labour market.
"The evolution of labour market pressures over 2023 will be key for understanding the likely path of interest rates over the next few years. Should the labour market remain tight, despite the RBNZ’s rapid rate hikes and high levels of net migration, it would be difficult to see the RBNZ feeling comfortable easing up on the hawkishness much any time soon. Feedback loops between wage growth and the cost-of-living have the potential to see inflation remain high without making the average worker any better off in real terms."
Robinson and Zollner say The devastating impacts of Cyclone Gabrielle are "another complicating factor" for the RBNZ.
"While the full cost of this disaster will not be known for some time, it’s clearly going to be inflationary both in the near and medium term. The very items in the CPI which were expected to help drive disinflation over 2023 (construction costs, food prices, and rents) now face significant upside risks due to immediate cyclone impacts (at least at a regional level), as well as what’s looking like a significant and lengthy repair job to houses and infrastructure."
The economists say there are "plausible scenarios" in which the OCR ends up significantly higher or lower than their baseline forecast.
"However, with global economic momentum picking up again in early 2023, the labour market still beyond maximum sustainable employment, and Cyclone Gabrielle posing further upside risk to domestic inflation pressures, it’s fair to say that we see the risks being tilted firmly towards the OCR being lifted higher than our current expectation of a 5.25% peak.
"That’s not to suggest the risks are one-sided. Monetary policy acts with a lag, and its impact on the housing and construction sector is just getting going. The spill-over impacts of this could be larger than we are reckoning on. Globally, the end of the era of practically-free and certainly easy money is unlikely to be all smooth sailing, and that could at some point make a more abrupt and deep hole in demand than expected.
"But assuming the wheels stay on, we do see the risks as tilted towards inflation not falling either as fast or as far (or both) as we and the RBNZ are forecasting, which is pretty much a straight line back to 2%.
"Real life tends to get in the way of tidy stories like that."
78 Comments
Well, the wheels will fall off in the housing market, but with insurance claims coming in thick and fast for vehicles, appliances, furnishings and all other household goods - I suspect these weather events will keep economic expansion/inflation up for quite a while.
Someone ought to monitor Briscoes sales - I bet they move from every week a half price something - to every second or third week - and from every month everything at 50% off, to that becoming very rare. Just a guess.
The ocr will peak way above where it is now. Inflation remains high and all the local contributors are also still rising. The floods will be one of many potential (foreseeable) black swan events that will work to scupper the chances of locally caused inflation dropping anytime soon.
Definitely popcorn time.
I have been saying it for a long time that the government will raise the target. I am expecting that it will go to 2% - 4% range. With the reasoning this is the new normal. There was never an economic rationale for 1-3% it was just an arbitrary figure picked by governments worldwide.
God wants 2% inflation over 50 years for the jubilee.
"The spectacular increase in net migration in recent months" does what?
That's right. Increases demand across the board. From accommodation to transport to food, and the increase in materials/services needed to fuel their work effort. And all of that will add to CPI.
Unless or until we get an OCR above the CPI we will just chase costs ever higher. What would any of us do to our price list if we knew the OCR still had further to go as Inflation ran away from the RBNZ? Drop them is not the answer. Add in importation of workers, and that terminal OCR is going to be way higher than 5.5% Way higher.
Here is a link to the Massey University website showing the OCR needs to be 8%+
Someone should remind economists and policymakers that NZ is no longer an industrial society where every extra pair of hands can be put to work in critical sectors reeling with acute skills shortages.
More than half of workers arrive in NZ on visas (working holiday, post-study work, partnership, etc.); the same for PRs that are issued on a skill-agnostic basis (family, humanitarian, etc. streams). Many of these do little to alleviate the critical supply pressures but certainly add to aggregate demand for basic goods and services.
Inflation of non-tradable items in NZ was persistently stuck in the 2.5-3.5% range from 2014 to 2019, coinciding with the period of spectacularly high net migration.
In Australia, only one quarter of permanent residents come in on a skills visa. The rest are hangers on. I would not be surprised if the same applies in NZ
https://www.macrobusiness.com.au/wp-content/uploads/2023/01/Capture-109…
The "spectacular increase" in net migration in recent months does, however, point to an improvement in the availability of workers, which should ease some of the logjam in the labour market
Right, because spectacularly high levels of net migration from 2014 and 2019 meant that NZ had a surplus of doctors, nurses, engineers and other high-skilled workers in our economy.
So why would the skill makeup of migrants be any different going forward. Not like NZ is a worse place to live and work in than it was in the mid-2010s. [sarc]
"We therefore continue to expect the RBNZ will hike the OCR to a peak of 5.25% by May 2023, before holding rates at this level until at least the end of 2024."
oh yeah..just two more small rate increases...there is a tui ad right there
Six more ocr reviews in 2023.I can see them having to raise in each.That would put the ocr at 6.25% at a minimum and floating rates of 9.5%.More for low equity buyers.
Its going higher. Even the US terminal rate is now being priced at 6%.
https://www.bloomberg.com/news/articles/2023-02-08/big-bet-on-hawkish-f…
https://www.reuters.com/markets/rates-bonds/fed-might-raise-policy-rate…
Wow if this prediction comes true, people will be visiting the bank in Q1 2024, and then putting a trademe ad for boarders in the spare room/garage.Downsides of over priced units/tiny townhouses is they dont work well for situations like this for people in their 30s with a kid for example who finally got 'on the ladder'
Will we see a few billion missing from the household disposable budget -restaurants cafes entertainment retail etc .
Maybe I CAN buy in 2025!
I stayed in an Auckland city AirBnB one night where I realised that it was only a 2 bedroom apartment, and the woman had her two children sleeping in her bedroom with her (one of which was an adult child, the other around 10 years of age). Enterprising or simply desperate?
I can easily see the OCR peaking at 5.75%-6%, and staying at such relatively high levels (or a bit lower) for a long time to come.
Inflation is now firmly embedded, and it is going to take a long time at OCR elevated levels before it can be controlled.
Just a quick look at current 3-year swap rates confirms that higher rates are here to stay - for years, not months.
Most dumb kiwis think reducing inflation will lower prices back to when inflation was 1 - 3 %. Wrong!!!
The RBNZ lowering inflation just means the rate of further increases "ON AVERAGE ACROSS A SELECT RANGE OF PRODUCTS" WILL BE LESS.
SO.. YOUR BROCCOLI WENT FROM 99c to $2.99 in two years. IT WILL REMAIN AT $2 99 BUT WILL INCREASE FROM THERE DEPENDING ON THE INFLATION RATE ... ( * NOT TAKING INTO CONSIDERATION THE " SUPPLY / DEMAND EFFECT. )
There must be thousands who have 'rentals' that are treading water (I see plenty). At some point these owners will accept that the cap gains are not locked in and are evaporating at a faster and faster rate.
So if the gains are going, the property is going backwards and the net profit is also disappearing (but tax wise increasing) then why hold?
Seems to me the race to the exit should be well underway already. The denial must be really strong out there.
Cash out while you can.
the net profit is also disappearing (but tax wise increasing) then why hold
That largely applies to landlords who bought properties older than 20 years in the last 5 years or so.
Also, you have Luxon swearing to provide desperately needed relief from this "tax on renters" if in power. That is the same logic libertarians apply when claiming more competition in our economy will be detrimental to worker wages.
Or, is it a measure of the killing developers were making on buying 1/4 acre sections and building multiple three storey shit boxes on them? Tons of those still being built in Chch a the moment. Of the 32 mortgagee sales currently on trademe, it only looks like are few are obvious developer sales, so carnage in the residential developer sector doesn't seem to be happening yet.
Just count the number of townhouses that Williams Corp have put up for sale in the last 3 months (NZ wide trademe search using "withington" as the key word). All their unsold stock that they had to tenant out, ads on Facebook promising 12.5% yields on inner city townhouses.
$200m plans: Auckland Council, Housing NZ selling Fletcher land for 300+ homes
https://www.nzherald.co.nz/business/200m-plans-auckland-council-housing…
Possibly not dead and buried
New Zealand will be affected by the Global economic environment and settings.
This arvo we get:
Very high rates needed to stop US consumers: Bank of America CEO. Americans are spending freely despite one of the steepest runs of interest rate increases in history, posing further challenges to the Federal Reserve as it seeks to tame inflation (AFR)
If they get them. Ours will be even higher.
Labour is undoubtably in short supply...skills even more so, however the ability to pay remains constrained (increasingly so)....businesses (services) may wish to demand increased revenue but when push comes to shove survival is more important.
If theres one thing that the self employed avoid if at all possible its the reversion to being an employee.
Oil seems to have peaked in 2018, therefore the global economy has less energy available and this means a lack of ability to supply to goods we desire and need. obviously complicating factors such as covid and war in Europe, amongst other factors have not helped. However, nearly 18 months of smashing demand seems not to be working only stabilising inflation. During this time our demand for luxury goods has declined, and in turn prices of these goods have not risen by much yet the food prices keep going up. Brought a laptop the other day, sales everywhere and even cash bonuses for buying products. Clothing prices have not risen markedly due to people not being able to buy the goods or not wanting to.
I am interested in what the reserve bank will do once they raise interest rate to the point where many middle class citizens are struggling to make ends meet (arguably now). It's all the more surprising given we produce food for over 40 million people. I laugh each time I see 'maximum sustainable employment' and yet people a castigated for not getting a job. Its going to be much harder having to compete against migrants who will demand the food that keeps on rising in price, are alsoprepared to live in standards of accommodation that we would not accept ourselves and will accept any wage under poor conditions just for a chance to reside here permanently.
I also think the talk about 'how bad it is in New Zealand' and the commentary I see asking why anyone would want to move here belies how horrific it is in other developed nations - stories out of the UK are not good. No food on shelves ect. People can still live a better life here in New Zealand than their own countries. It is just that we are very cognisant that our own living standards are declining.
Despite this, at least New Zealanders will always be able to buy food, unlike other states that will struggle to fulfil such basic needs.
I have a friend here from Germany currently who attests that the cost of meat and many other food items here is vastly cheaper than in Germany currently, as due to the price of diesel and inflation, anything trucked into the country across Europe has been hiked in price astronomically. He noted 2 rump steaks would likely cost around $30NZD equivalent among other examples. People come here either for opportunity relative to their own country, to work here for a while and leave such as working holiday visas, as a gateway to Australia once they get citizenship (quite common), or for lifestyle due to the geographical variety we have here (think Christchurch where you can ski in the morning and be at the beach in the afternoon etc).
Yip, anecdotes are sometimes useful. It's going to be an interesting year that is for certain, as the article states, inflation may not go away. Added to this if we have another extreme weather event - seems possible given the past several years of flooding across the country. Cyclone Gabrielle has caused immense damage that will take years for some businesses to recover.
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