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Roger J Kerr says rising commodity prices pose a significant risk to the RBNZ’s 'lower for longer' inflation and interest rate view and policy setting

21st Mar 16, 11:42am by Roger J Kerr

By Roger J Kerr

A respected company director, active as a commercial/industrial property consultant and advisor, told me a story last week as we both sat at a breakfast function waiting for Governor Wheeler to deliver has standard post MPS presentation.

A property investment client of his has just received Auckland Council resource/building consent for an upmarket apartment development in a central city suburb. The development has been sold off the plans and was all set to start, however it will not happen anytime soon as there is a 12 month wait time for the vertical concrete slabs that are fundamental to the building construction.

What does such a chronic supply shortage in the building industry tell you about the direction of prices in that sector?

Demand is clearly so strong that building material suppliers are totally stretched on their forward order books and are giving 12 month delivery time.

A large residential property development in South Auckland went bust recently as the land/house packages sold off the plans were set at a sale price two years’ ago and house construction costs have subsequently increased so much the venture was just not viable. Someone else may pick the development up and build inferior quality houses a lot closer together!

The upward momentum in construction costs are no longer driven by the demand for resources coming from the Christchurch re-build, instead they are driven by population increases in Auckland and low mortgage interest rates.

It appears that the RBNZ put more faith in their beloved “surveys of inflationary expectations” than alarming anecdotal evidence of supply/demand mis-matches described above.

However, sharply rising prices in one sector do not automatically lead to increases in general inflation. If there are sufficient price decreases in other parts of the economy, the inflationary increases are offset and disguised. A problem arises when those other price falls are no longer occurring.

Substantial falls in oil and commodity prices up until a few weeks ago have disguised other material price increases in the economy.

The sudden 50% recovery in crude oil prices from the lows of US$25/barrel (WTI) to the current US$39/barrel is now being witnessed at our service station pumps. A significant risk to the RBNZ’s “lower for longer” inflation and interest rate view and policy setting is that commodity prices continue to increase at the rate they have lifted over recent weeks. Fiscal stimulus measures from the Chinese government for their house building industry is one of the reasons behind the sharply higher iron ore prices.

Excessive liquidity sloshing around the world looking for some kind of yield return is the main reason why US and NZ government bonds yields have reached new lows. Investors frightened into buying safe haven bonds at the time of the January sharemarket turmoil should be now be reconsidering their strategy with the rebound in equities and commodities over the last six weeks showing that the world is not such a scary place after all.

The disconnect between US core inflation trends (higher) and US bond yields (lower) is now very pronounced and does not appear sustainable, no matter what the Fed may be saying right now (refer chart below).

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Source: NZFMA

Roger J Kerr is a partner at PwC. 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

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12 Comments

by Craig | 21st Mar 16, 12:24pm 1458516286

"What does such a chronic supply shortage in the building industry tell you about the direction of prices in that sector"

That the building companies should manage their work better and be less greedy about selling when they obviously can't make what they are selling.

by steven | 21st Mar 16, 12:55pm 1458518133

or that Roger's gut has been wrong for 8 years now, time to look at the data maybe? A real economics model?

by head_down_bum_up | 22nd Mar 16, 10:28am 1458595725

"What does such a chronic supply shortage in the building industry tell you about the direction of prices in that sector"

That we should get in to the concrete business?

by dictator | 21st Mar 16, 12:38pm 1458517126

No point fearing inflation at this point. Yes the construction industry is busy and some people don't talk to their builders and consultants about what the constraints are at this time. Nothing new there. Thing is there would be more work if there weren't so many obstructions and delays to obtaining a building consent.

There would also be a big boom in construction if everyone didn't view this as short term and being unwilling to invest in adding more capacity. Further to that you need skilled and capable workers but if they don't exist it's not possible to expand your business.

Overall there doesn't seem to be enough construction to create oversupply but it will eventually fuel inflation, just not in the near term. Enough fearing inflation, it's something we would welcome back now. I'll keep trying to free up money in my little part of the construction economy however it's still not flowing freely enough.

by Andrewj | 21st Mar 16, 12:39pm 1458517143

http://www.stuff.co.nz/business/78003430/builders-get-tough-on-making-c…

by BadRobot | 21st Mar 16, 5:52pm 1458535923

I read that article this morning as well. My impression of Christchurch is that t has been running at full steam for the past five years and now much of the stimulus has been removed i.e. the residential rebuild is largely over, still some way to got but nowhere near the same level as the past. Where does this leave Christchurch businesses - I don't know - and I'm scared to guess. - but I suspect that building related businesses failures will become the norm for a while, not to mention the farming industry problems. I suspect there may be a few lean years...

by steven | 21st Mar 16, 12:52pm 1458517951

Unsure where you get your data from but,

http://www.tradingeconomics.com/united-states/inflation-cpi is 1% and dropping back.

While core is indeed rising, but only 2.3%, http://www.tradingeconomics.com/united-states/core-inflation-rate

US food prices is at 0.9%, http://www.tradingeconomics.com/united-states/food-inflation

Also GDP is dropping back as well, http://www.tradingeconomics.com/united-states/gdp-growth-annual

Sort of strange that most data seems poor; declining, flat or slight rise yet you are showing 4.7%? seems rather strange.

by jimmyjohns | 21st Mar 16, 1:51pm 1458521504

The graph has two scales - you're looking at the one for bond yields rather than CPI inflation.

by Rumpole | 21st Mar 16, 1:06pm 1458518775

I wonder if Rogers source is the Brown Book located just North of his chair seat.

by Stephen Hulme | 21st Mar 16, 4:13pm 1458530007

Excessive liquidity sloshing around the world looking for some kind of yield return is the main reason why US and NZ government bonds yields have reached new lows.

There is probably more concern, created by negative interest rates, that an actuarial hole needs to be filled irrespective of the reluctance of some pension plan managers to correct the discount factor to reflect today's realities rather than the past.

As those of you who follow the CalPERS soap opera may recall, California Governor Jerry Brown pushed for the giant pension fund CalPERS to lower its assumed investment return from 7.5% to 6.5%. Given that the world is headed towards deflation and that CalPERS earned only 2.4% for the fiscal year ended June 30, 2015, Brown’s request seemed entirely reasonable. Instead, the board approved a staff proposal to move to the 6.5% target over 10 years. Read more

by Boatman | 21st Mar 16, 4:55pm 1458532532

Roger , the ever-so-slight increase in commodity prices is more a factor of US$ weakness than a sustainable increase in commodity prices .

The horrible truth is , the world has too much oil , too much iron ore , too much coal and too much milk , and heaps of excess capacity in industry and manufacturing for inflation to even be on the horizon

by linklater01 | 22nd Mar 16, 9:36am 1458592579

What a great start to the day-a gross 79 at golf and now a bit of comedy from Roger.

Roger; have you only now discovered that the construction industry has been experiencing higher rates of inflation? Despite that, the overall rate has been declining. Oh,but what about oil? In Roger's world, the price will presumably just keep rising, but what if it doesn't? Go and look at the Baltic Dry Index. Global growth is slowing, not growing and it will be some time before our inflation rate tests the 2% level.