Core inflation has barely budged in the past nine months and may stick around until unemployment begins to rise, economists suggest

While headline inflation continues to decline, economists are worried prices are still climbing in the most visible and persistent parts of the economy. 

Brad Olsen, Infometrics chief executive, said there was still an intensely hot core of inflation among everyday items such as food, energy, and rental costs that shape expectations. 

International oil prices have flowed through to lower transport costs but household living costs are continuing to rise at a significant pace. 

Non-tradable or domestic inflation was running at 6.6% in the June quarter, on an annual basis. That’s above the Reserve Bank’s forecast of 6.3% and ANZ’s 6.4%. 

The annual rate of inflation dropped to 6% in the June quarter from 6.7% in the March quarter. It peaked at 7.3% in June 2022.

Henry Russell and Miles Workman, economists at ANZ, said the price pressure was spread broadly across sectors and wasn’t due to idiosyncratic movements in one or two components.

The falling headline rate was due to cheaper imported goods, lower shipping costs, and a much weaker international oil price. All things the central bank has little-to-no control over. 

“Overall, today’s data suggest that underlying inflation is proving persistent, which will be a big worry for the RBNZ,” Russell said in a note. 

“Monetary policy is working to cool inflation pressures, but there’s a long way to go, and it’s not clear that progress is fast enough”.

Most core inflation measures are showing some evidence of moderation, but not the Reserve Bank’s own ‘sectoral factor model’ flagship which has been stuck at 5.8% for the past three quarters. 

There were other concerning trends under the hood as well. Almost 85% of all items included in the index were running above the 2% target, even as the proportion running above 5% fell. 

“That suggests extreme inflation is now fading, but at the same time, inflation could be normalising above the RBNZ's target midpoint of 2%,” Russell said. 

“It’s a long way back to target and that challenge will become increasingly evident once the low-hanging fruit of base-effects has all been gathered”. 

Strong wages support inflation 

Kiwibank economists said the world war on inflation was being won, but the domestic battle was still being hard fought. 

Mary Jo Vergara, a senior Kiwibank economist, said half of all NZ’s inflation had been imported and that element was fading fast. 

It fell to 5.2% in the June quarter, down from 6.4% in March and a peak of 8.7%. 

But getting back to 2% required bringing down “stickier, demand-driven” domestic inflation, which was made more difficult by the steady increase in wages. 

Multiple economists said non-tradable inflation was unlikely to drop back into the target range without some weakening of the labour market.  

Most now expect the Reserve Bank to lift the Official Cash Rate (OCR) another 25 basis points to 5.75%, if not further. 

Only two components of the entire consumer price index (CPI), transport and communication, declined across the quarter, with the rest of the headline fall being due to base-effects. 

Kim Mundy, a senior economist at ASB, said the June quarter included some inflationary impacts from Cyclone Gabrielle and the Auckland flooding. 

For example, dwelling maintenance services rose 1.7% and insurance premiums lifted 3.1% during the quarter. 

“The extent to which the RBNZ expects these price rises to be temporary will be an important consideration in terms of the policy implications,” she said in a note. 

But there are future inflation pressures on the horizon as well. The September quarter will include impacts from tax changes, such as the discounted fuel tax and council rate hikes. 

No-one expects inflation to pick up pace again, but its descent will slow as the easy parts are picked off first and tougher battles are fought. 

Watch, worry, and wait  

Craig Ebert, a senior economist at BNZ, said the 6% CPI would help to dampen inflation expectations and keep indexed prices from increasing too fast. 

Elsewhere, he saw encouraging signs that inflation was being squeezed out of the economy despite what might be a disappointing quarter for some.  

“If we didn’t know better, we would have viewed today’s CPI report as keeping a degree of pressure on the RBNZ. But … there are already strong disinflationary forces running through significant parts of the NZ economy,” he wrote in a note. 

Export commodity prices were falling which would have a negative impact on the economy, and therefore inflation. 

Gross domestic product has been flat, if not falling, and business surveys show it has been easier to find available staff. Capacity constraints are easing more generally, as well. 

Ebert said global inflation was going through a similar process to inflation in New Zealand. 

“Clearly moderating in a headline sense but running into degrees of stickiness with respect to core inflation (underpinned by resilient labour markets).”

“Looking at the latest consensus forecasts, they expect CPI inflation, across the world, to slow to 5.3% in calendar 2023, then 3.6% in 2024.”

BNZ has forecast an annual inflation rate of 5.9% in the September quarter and 4.7% in the December quarter, while the RBNZ has guessed it will be 5.7% and 4.9%. 

At its last policy meeting, the central bank said it was expecting headline inflation to fall from its peak and bring expectations down with it. 

But Ebert said it was less definitive in its comments about core inflation, saying only that it was expected to decline when capacity constraints ease.

“This suggests a degree of tolerance, at least timewise, to witness core inflation falling. With so many leading indicators pointing downward, we need to trust the lags in bringing inflation to heel,” he said. 

Financial markets were pricing in a decent chance of another increase to the OCR in November, but were little changed by the CPI data release on Wednesday.