Roger J Kerr says the real conundrum facing the Reserve Bank this week when looking at inflation forecasts is deciding when we will see wage increases feeding into higher costs

By Roger J Kerr

The Reserve Bank of New Zealand have a scheduled OCR review this Thursday 23rd March and it will be interesting to observe what points they focus their statement on in terms of global risks, the NZ economy and thus inflation trends.

They should comment on the depreciation of the New Zealand dollar from 80.0 to 76.0 on the TWI Index and that further depreciation would force them to bring forward inflation increases in 2017.

On the other hand the GDP growth towards the end of 2016 was less than expected.

In terms of capacity utilisation in the economy, I would see the situation as unchanged as the lower growth was climatic related and not really a change in the demand side of the economy.

Any inflationary pressures from increasing fuel costs have abated as crude oil runs into the ceiling caused by shale producers in the US adding to the supply at prices above US$50/barrel.

Crude oil (West Texas) prices have fallen back to below US$49/barrel. Counteracting lower fuel prices is the big jump up in food prices over recent months.

However, the real conundrum for the RBNZ in reviewing their 12 to 18 month inflation forecast is how and when increases in wages will feed into business firm’s cost structures, and thus into end-product, price-setting, behaviour?

The strong immigration inflows have not happened by accident, they are due to NZ businesses demanding skilled labour to meet their needs and they are sourcing that labour from overseas as it is not available locally.

Whilst that “demand-push” immigration trend continues, the increases in wages you would normally see at this stage of the economic growth cycle will not happen.

The RBNZ’s econometric models would have been indicating wage increases occurring by now, but it is just not happening.

A couple of businesses I am personally associated with in the financial services arena are currently advertising  for people in Sydney as they cannot source the quality/experience they require from the local labour market.

The abundant supply of labour willing to come in from overseas is continuing to keep wages increase very subdued. 

I think the wages conundrum will continue in the current vein for the RBNZ and this really clouds 2017 and 2018 inflation forecasts.

US long term interest rates (10-year US Treasury Bonds) have corrected down 10 points from 2.60% to 2.50% following the Fed’s 0.25% increase in short-term rates last week.

The interest rate markets got themselves into a frenzy ahead of the Fed meeting that the previously signalled pace of interest rate increase over the remainder of 2017 and 2018 would be shoved up.

That of course did not happen and there was some market disappointment as a result. I see the pull-back to 2.650% as temporary and continuing stronger economic data in the US will soon turn the market sentiment and direction back to increasing long term yields.

Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com