Influential RBNZ survey shows a slight rise in the expected level of inflation in two years time

A survey the Reserve Bank (RBNZ) pays close attention to has shown a slight rise in the expected level of inflation in two years time.

The results of the latest Survey of Expectations, carried out quarterly for the RBNZ, will carry weight with the central bank in making its next decision on the Official Cash Rate on Wednesday, August 16. This latest survey result will not change the RBNZ's mind on anything, but it may give it some pause for thought. The RBNZ is widely expected to leave the OCR unchanged.

Economists had expected the inflation expectations to fall and it is to be presumed the RBNZ will have as well. It is likely the survey respondents may have been influenced by the June quarter Consumers Price Index figures, which showed domestic inflation falling only to 6.6% from 6.8% when a rather larger fall was anticipated. The worry is that domestic inflation is going to prove 'sticky'.

At the moment the OCR is at 5.5%. When raising the OCR to that level in May of this year the RBNZ indicated through its forecasts that it would not be raising the OCR any more in the foreseeable future.

The key result in the survey is that the expectation for inflation in two years' time - the most watched measure in the survey - has risen to 2.83% from 2.79% three months ago.

Westpac senior economist Satish Ranchhod said the latest survey "is a bit of a mixed bag for the RBNZ".

He noted that inflation expectations "remain above the 2% target mid-point even at longer horizons".

"That’s despite the large rise in the OCR over the past two years and sharp fall in headline inflation in the June quarter to 6% (down from 6.7% previously).

"The Survey of Expectations does not play a major role in the RBNZ’s forecasting process. However, it does provide background colour on the economic landscape. And the message in today’s release was similar to that in other recent business surveys: price pressures are easing, but only gradually. That means the RBNZ still has a long road ahead of it to get inflation back to levels consistent with its target.

"We expect that the RBNZ will keep the OCR on hold at next week’s policy meeting. However, with linger strong domestic inflation pressures, we continue to expect another rate hike before the end of this year, most likely in November," Ranchhod said. 

The RBNZ seeks to have inflation within 1% to 3%, with an explicitly targeted 2% level. So, what it looks for from this survey is for inflation expectations to be comfortably 'anchored' at around 2%.

Expectations of high inflation are a killer, since these expectations get baked into future pricing and wage intentions. And with annual inflation - measured through the Consumers Price Index at 6.0% as of the June quarter - now having been outside of the RBNZ's 1% to 3% target range for over two years, the RBNZ wants those inflation expectations to wither as soon as possible. 

The key point around this particular survey is that regardless of how accurate the forecasts prove to be - and if you look back you'll find they haven't been accurate - what the RBNZ really wants to assess is how confident the 'market' is that it, the central bank, will be able to control inflation in future. 

And clearly, if the survey respondents are forecasting inflation in two years' time of over 3.5% - as was the case in this survey at the end of last year, well then there's a lack of confidence out there that the RBNZ has matters at hand.

All of which is a slightly long way around of saying that the RBNZ's efforts are gradually winning over the 'market', but people are still not completely convinced. 

Looking further forward the survey shows the expectation in five years' time is that inflation will be on 2.25%. That's down from 2.35% in the last survey.

In terms of 10 years out, the expectation in the latest survey is for a rate of 2.22%, down from 2.28% in the last survey. 

The data for the latest RBNZ survey was obtained from 30 business leaders and professional forecasters by the Nielsen group on behalf of RBNZ. Field work for the survey was run between July 20 and July 28, 2023.

Separately, the survey also included the views of respondents on where they see the REINZ House Price Index in one years' time and two years out. Since the last survey three months ago the views have become somewhat more rosy. 

For the first time since the survey in the last quarter of 2021 house prices are expected to rise over the next year. The view of prices two years out is now for a slightly bigger rise than was seen in the last survey three months ago.

The RBNZ said the mean estimate for annual house price growth one year ahead rose 431 basis points to +1.42% from the previous quarter’s estimate of -2.89%. The mean two year ahead expected annual house price change was +4.42%, which was 78 basis points higher than last quarter’s mean estimate of +3.64%.

In a separate release the RBNZ said it is reviewing the Survey of Expectations and this will include a new survey provider.

The central bank said that following a competitive procurement process survey of expectations fieldwork will be carried out by Research New Zealand – Rangahau Aotearoa from October 2023. The contract with The Nielsen Company expires in September 2023.

The RBNZ has begun investigations to broaden survey coverage and expand the sample size to increase the statistical quality of results. It will also review the survey methodology and the questions we ask respondents.

It is planned to conduct a public consultation to elicit feedback on the proposed approach to survey enhancements over the coming year.