Economists see short term inflationary pressures due to one-off costs, but expect these to recede as the year goes on and see little imminent need for interest rate rises

Economists at the big banks see inflation figures to be released this week (Wednesday, March 21) as falling short of the Reserve Bank's forecast.

And while they see inflationary pressures building by mid-year, they expect these to recede as the year goes on, meaning that there's no imminent prospect of higher interest rates.

The RBNZ in its last Monetary Policy Statement (page 44) forecast a 1% rise in the Consumers Price Index (CPI) for the March quarter, producing an annual rate of inflation of 1.7%.

Remember the central bank officially aims for 1% to 3% annual inflation, with an implicitly targeted 2%. 

In the December 2020 quarter, the CPI rose 0.5%, giving an annual inflation rate of 1.4%.

Westpac senior economist Satish Ranchhod is expecting the official figures out this week will show March quarter consumer prices rose by 0.7%.

"That would see annual inflation slipping back to 1.3% (down from 1.4% in December).

"Our forecast is lower than the 1% quarterly increase assumed in the RBNZ’s last set of published forecasts from February. That’s mainly due to our lower forecast for tradables prices which in part reflects the flattening-off of food prices over the quarter."

Stimulatory policy settings

Ranchhod noted that last week the RBNZ signalled that it expects to maintain very stimulatory policy settings for an extended period.

"A result in line with our forecast would reinforce that view."

He says annual inflation for the year to March will be restrained by a change to the normal adjustment in tobacco excise taxes. In recent years, those taxes have risen by around 10% per annum as part of efforts to discourage tobacco consumption.

"This year’s increase will be much more modest– we’re expecting a 1.4% rise in line with the trend in overall prices over the past year. Compared to what we’ve seen in recent years, that change will shave about 0.3 percentage points off annual inflation."

He says looking at the broader trends in prices, inflation pressures are building, with core measures trending back towards 2%.

"In part, this has been underpinned by disruptions to global manufacturing and shipping in the wake of last year’s [Covid] outbreak, as well as the related increase in commodity prices. The resulting shortages have seen rises in the prices for some imported consumer goods (or at least less discounting than usual). Supply disruptions are now also spilling over into increases in costs of production in sectors like construction. We expect this will boost consumer prices over the coming months."

He sees annual inflation jumping to around 2.5% by the June quarter. Much of that is due to base effects – oil prices are substantially higher than they were in mid-2020, in the depths of the Covid shock. More recently there’s been upward pressure on import prices due to global supply chain disruptions and a spike in shipping costs.

One-off factors

"But these are likely to be one-off factors, rather than a source of sustained price increases. As the initial effects fade, we’ll be left with an economy that’s still running short of its full capacity, mostly due to the international border closure. We expect that by next year annual inflation will be back in the lower half of the RBNZ’s target range. That means the conditions for a tightening of monetary policy could be quite some time away."

ASB senior economist Mark Smith is expecting a 0.8% March quarter CPI increase, which would see annual inflation edging up to 1.5%. He too expects annual inflation to push up towards 2.5 by the June quarter and remain above 2% for most of the next year or so due to a combination of cost shocks and increasing capacity pressures in some pockets.

"The inflation outlook is still uncertain, with the RBNZ likely to defer from increasing the OCR until it is confident inflation will trend above 2% and the path of the economy and labour market are on a sound footing. 

"For now, we expect the RBNZ to remain patient and defer from raising the OCR until it is confident the expansion is secure, the economy is close to full employment and medium-term inflation drivers are pointing well above 2%. This still some way away and we have pencilled in August 2022, with risks of a later start to OCR hikes."

Smith said we have already seen cost and pricing metrics from business surveys lift, with regulatory changes (e.g. removing interest rate deductibility) likely to add to upward pressure.

"Our CPI profile is noticeably firmer than February MPS forecasts. Even with these factors, however, there are few signs of the economy overheating, with inflation still looking to be comfortably within the 1-3% inflation target range. Moreover, the further ahead you look the greater the uncertainty and the inflation outlook can move swiftly as developments change. We will be keeping tabs on key medium-term inflationary drivers – including inflation expectations, capacity metrics, and wage growth – and the wider economic and labour market outlook for signs of economic overheating. The RBNZ can rest easy, for now."

He says market reaction from the March quarter figures should be modest.

Erring on the side of caution

"Our view is that the RBNZ has erred on the side of caution by putting out a high set of Q1 inflation numbers in the February MPS, with risks tilted to the downside. Moreover, the RBNZ and other central banks have been at pains to signal they will accommodate what looks to be a temporary spike in inflation. The RBNZ in Wednesday’s Monetary Policy Review expected a “prolonged period to pass” until CPI inflation will be sustained at around 2% and employment will be at (or above) its maximum sustainable level. To us this looks to be more than a year away: we have pencilled in the next OCR hike being in August 2022 or a bit later."

ANZ economist Finn Robinson and senior economist Miles Workman expect that CPI inflation rose 0.7% in the March quarter.

"Supply chain disruptions, rising import costs, higher oil prices, and a booming housing market are all putting temporary upwards pressure on the prices consumers face. But the transitory nature of these drivers mean that the RBNZ is unlikely to be swayed from their watch, worry and wait stance," they say.

They say  there is the risk that all these supply pressures and rising costs do bleed through into broader price-setting behaviour, and become embedded in higher inflation expectations.

"This could put the RBNZ in an uncomfortable position with inflation pushing above their target band much sooner and for longer than expected, and this could see them facing a trade-off between keeping inflation contained and supporting the labour market.

"But the bottom line is that the economic damage from COVID-19 still represents a pretty significant income shock (one that’s been partially transferred to the future by loading up on debt), and that points to a still fragile underlying demand pulse over the medium term. But in the near term we see temporary supply chain disruptions, closed borders, and labour market mismatch issues keeping inflation buoyant. But, eventually when borders open and supply issues start to subside, we may be faced with an economy that’s continuing to struggle with residual capacity (ie a negative output gap). So for the RBNZ, it’ll be a pretty high hurdle for [this] week’s inflation outturn to challenge their wait and see stance."