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A research note published by UBS warns traders that the Reserve Bank (RBNZ) has not cut interest rates while domestic inflation has been this far above target in over two decades.
Headline inflation in the June quarter was 3.3%, slightly outside the target band, but this was largely driven by lower prices for imported products. Non-tradable inflation remained historically high at 5.4%, compared to a pre-COVID average of about 2.6%.
Non-tradables are a category of prices in the Consumers Price Index (CPI) basket that do not face international competition. Housing costs and household utilities together make up 29% of this category.
The rest includes health and education services, recreation and culture, communication services, household items, vehicle purchases and servicing, insurance, local authority rates, and certain food and drink items that do not compete with imported products.
Policymakers and economists often focus on non-tradable inflation because it better reflects local cost pressures and economic conditions compared to headline inflation.
Nic Guesnon, an economist at UBS, said the RBNZ is focused on non-tradable inflation and is unlikely to cut interest rates based solely on lower international prices.
The RBNZ's monetary policy committee may be hesitant to predict a continued drop in tradable inflation, as prices might rise again due to a recent increase in freight costs, he said.
The Official Cash Rate's currently at 5.50% where it has been since May last year.
Not so fast
Many bond traders expect the central bank to preempt falling inflation and start cutting rates as early as next month, when it delivers its next monetary policy statement.
In a note to clients, Guesnon said his analysis of the RBNZ’s past policy responses suggested it is more likely they will wait until November before easing rates.
“In the last 20+ years, the RBNZ has not started cutting rates when [annual] non-tradables CPI available at the time of their meeting was as high as Q2's outcome of 5.4%,” he said.
There have been times when non-tradable inflation was relatively high at the time of a cut—such as in 2011 when GST was hiked and the Christchurch earthquake occurred—but never above 5%.
The RBNZ will update its forecasts next month, but in May it expected non-tradable inflation to drop to 4.7% by December 2024, which would only be confirmed in January's data release.
Guesnon said it may be difficult for the Monetary Policy Committee to ease its policy when domestic inflation is widespread and slightly above the RBNZ’s forecast for the June quarter.
“When the RBNZ digs into the details, they are unlikely to feel comforted by the breadth of price increases domestically. Practically all CPI groups rose above the RBNZ's target band…”
The groups least affected by monetary policy—such as insurance, property rates, alcohol and tobacco, and health—saw the largest price increases, with some items rising by over 9% annually.
“However, what we found surprising was how many other groups, which should be more sensitive to the weak economy, were still rising rapidly in [the June quarter],” he said.
This includes housing (excluding property rates and charges) at 3.8% annually, transport at 9.2%, communication at 4.0%, and recreation and culture at 5.7%.
Domestic debate
Other economists have identified a few inflation hotspots that are keeping non-tradable inflation above target. ASB argued that some “cost-driven” increases should be ignored as they won’t significantly impact wages and other prices.
“Stripping out some of these cost increases suggests that annual underlying CPI inflation is already well below 3%, and it looks set to continue to cool,” they wrote earlier in July.
ASB now expects 25 basis point rate cuts in both October and November, based on the assumption that core inflation has fallen to its lowest level since the spike began in mid-2021.
Kelly Eckhold, chief economist at Westpac NZ, forecasts the first rate cut in November, but is much less optimistic about domestic inflation.
In a recent note, he reminded clients that non-tradable inflation has consistently exceeded the RBNZ’s forecasts, including in the most recent quarter.
Additionally, non-tradables excluding the so-called problematic hotspots (such as housing, insurance, and taxes) remained very elevated at almost 6% year-on-year.
Core inflation is falling, and headline CPI was likely to slip below 3% in the September quarter, he said, but lingering strength in non-tradables means 2% was “still a long way away.”
With domestic inflation pressures elevated, there might be no case for the RBNZ
to cut rates this year, except that most economists believe inflation will fall quickly from here.
Guesnon said non-tradable inflation should ease “more noticeably” in the next two CPI releases, given that the local labour market has been loosening.
Other leading indicators suggest the NZ economy has been contracting, with an unusually high number of firms laying off workers.
Since monetary policy operates with a long delay, the central bank may need to lower interest rates before reaching the 2% target midpoint to avoid unnecessarily harming the economy.
15 Comments
Jamie Dimon has a similar take on things about 'sticky inflation'. Doesn't mean they won't cut in Nu Zillun to appease the sheeple in some way. Just be prepared for the consequences of trying to massage the Ponzi while your spending power gets wrecked.
"I think the underlying inflation may not go away the way people expect it to," he told the outlet at the JPMorgan Global Markets Conference. He added: "I think there are a lot of inflationary forces in front of us that may keep it a little bit higher than people expect."
https://www.msn.com/en-us/money/markets/jamie-dimon-says-inflation-is-w…
Great work from the reckonomists. Must keep those domestic business costs high to persuade domestic businesses to moderate price increases. Meanwhile, at the aggregate level, businesses are disappearing under water and jobs are now evaporating at pace. Here's what Stats NZ said a couple of weeks ago when they released the latest national accounts data....
'Interest paid increased by a further 2.2 percent to $7.2 billion in the March 2024 quarter. Interest expenses make up 28 percent of income payable in the latest quarter, and 14 percent in the September 2021 quarter when interest paid was at its lowest level in the series ($3.0 billion).
Businesses have taken on more debt and reduced their inventories to fund the difference between income and outgoings. The last year has seen three of the four highest quarters in the series for new borrowing, with $18.4 billion of new borrowing in the year ended March 2024. Over the same period, net inventories declined $5.2 billion reflecting businesses using or selling inventories without fully replacing stocks'
Of course, while businesses are taking on more debt to stay afloat, and paying out interest, on the household side of the balance sheet it is happy days for savers. Yes, in the year 2024, we tackle inflation by taking money from struggling businesses and households, and handing it over to wealthy savers and bank shareholders. What flavour of madness is this?
Cruel irony being, how many of these wealthy savers have effectively licked both sides of the economic lolly pop?
Sell a housing asset at near peak values off the back of low interest rates, and then have their second helping while the source of their gains are shuffling a huge amount of interest dollars their way.
Central Planning AKA Central Banking, continues to work about as well as expected. Turns out the Reserve Bank Monetary Politburo of NZ are no better at solving the economic calculation problem than the Soviets were. Surprise surprise.
What the government needs to do is just declare cryptocurrency legal tender (to remove cap gains for using as a currency) then let the market work it out. The lack of competition in currency is what got the world to this point, only way out is to put some competitive pressures into the system via crypto or even declaring foreign currencies legal tender.
What a trainwreck.
This has already become worse than the GFC now in NZ. We were not hit as hard back then. I worked in retail and the pay was crap and we had a pay freeze. But things were getting better. Why cant we just have the higher inflation? Reduces asset value (houses ect), wages will continue to go up, reduces student loans ect.
Inflation is a thief in your wallet Orr says....Sure if you have assets and massive savings. I'd rather slightly less in the pocket with a job rather than no job, or reduction in hours and no prospects for better employment.
Trainwreck.
I’m surprised a comment like that hasn’t been torn to shreds by a lot of the jokers on here who seem to be getting a kick out of watching the economy shit itself…I agree, paying more for groceries is better than not being able to buy any groceries at all due to loss of employment…they dropped the OCR too low & held it down there too long…should’ve raised to hit the neutral rate swiftly when it was obvious that they didn’t need to stimulate, inflation would’ve moderated while the economy wouldn’t have hit the fan…can’t help but think they’ve absolutely cooked it 😬
What 'they' should or shouldn't have done doesn't matter now. It's history etc. What we could have done is rebalanced our economy. But we didn't and stuck to the only Debt based Property Speculative economy we know how to run.
All that matters is 'what will happen' and whilst no one knows for sure the risk is that by cutting interest rates (everywhere, by the look of contemporary commentary) the CPI(s) don't behave as hoped and prayed for. Then what? Oh, I know! The same as we did so recently. The OCR has to chase a runaway CPI figure using that hard-and-fast you allude to above. But this time it could be a Volker Moment on steroids.
As I've suggested previously, if we let CPI escape again, then the days of an OCR of just 8.25% will be looked back on fondly.
More pain now could mitigate disastrous consequences later.
We are staring the economic equivalent of White Island in the eye.
We've noted the seismograph telling us that danger was coming, and ignored it, as nothing happened last time.
Then...BOOM!... those innocently thinking all was safe end up dead. And the future meant no one goes to the island any more.
That's what we face, unless we take heed of the warnings. And they are, and have been, coming stronger, faster and louder.....
bw: "What 'they' should or shouldn't have done doesn't matter now. It's history etc."
Not so. Action needs to be taken to stop the ongoing damage!
The entire MPC can be forced to resign and a new one instigated.
This would almost certainly result in fresh approach.
One would hope for a more nuanced approach where the RBNZ acknowledge that:
a) waiting for data that is (at best!) 3 months out of date ... is nuts.
b) having the OCR a full 3.0% above the neutral rate as inflation has been falling ... is also nuts.
c) RBNZ action itself is contributing to higher costs that must be passed through resulting in ... wait for it ... sticky non-tradeable inflation.
Where are the NACTF in this?
Didn't they go into the election promising an inquiry into what the RBNZ has been doing? I further seem to remember senior National Party MPs firmly suggesting that Orr should / would be removed immediately after the election. Now, while tax receipts are plummeting, they're somehow just peachy and everything is tickety-boo?
bw: "As I've suggested previously, if we let CPI escape again, then the days of an OCR of just 8.25% will be looked back on fondly."
And as I've asked previously ... Prove it!
You won't be able to.
Why? Mainly because such statements are total b.s. without a significant black swan event. Maybe like a couple of devastating cyclones, massive hikes in imported energy costs, a pandemic with an out-of-control central bank, and major war all at the same time. Or a major global financial meltdown might do it (... for a day or two until central banks act and rates plummet to near zero). Do you have any evidence - outside the usual crackpot doomsday sources - of that? No? I thought not.
Inflation doesn't lower asset prices. High interest rates lower asset prices.
Low interest rates stimulate both asset and consumer prices, which is what was happening in 2021. It was only the fortunate circumstances of closed borders that enabled workers to leverage pay increases to keep up with that inflation. That's not going to be the case next time.
And here is some background about how you create non-tradable inflation with as an example: poor electricity market policies
https://www.nzherald.co.nz/business/why-electric-kiwi-is-closing-to-new…
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