Roger J Kerr says low inflation has only come about through the global technology revolution - but this has not stopped the price of household staple items increasing at a much faster rate

Roger J Kerr says low inflation has only come about through the global technology revolution - but this has not stopped the price of household staple items increasing at a much faster rate

Having been pounded down three cents from 0.6800 to 0.6500 over recent weeks against the USD, due to lower interest rates in Australia and New Zealand as well as the China/US trade wars starting up again, the Kiwi dollar is showing some tentative signs of attracting some support in the FX markets.

The NZD/USD exchange rate sat at 0.6500 for most of last week, however a slightly weaker USD in global forex markets later in the week allowed a partial recovery in the Kiwi dollar up to 0.6550.

Profit taking by speculators who short sold the Kiwi dollar in late March when RBNZ Governor Adrian Orr hinted that the next move in NZ interest rates would most likely be downwards, added to the Kiwi bounce back.

The move back upwards has seen the rate break out and above the downtrend line it has remained under since 0.6900 in late March.

Whether further buying interest is enticed into the Kiwi by this technical/chart change remains to be seen.

What can now be stated with some more certainty, in terms of the outlook for the NZD from here, is that the negative sentiment from expectations of lower interest rates is already fully priced into the exchange rate and therefore unlikely to cause further NZD weakness.

GDP growth numbers are the next pointer for NZD direction

Retail sales figures for the March quarter recording a 3.7% increase over the same quarter in 2018 was a timely reminder to the financial markets last week that the NZ economy is not stalling and falling into a hole as some pundits have been confidently predicting.

Manufacturing and service industry surveys have,however, been weaker over recent months as demand eases off somewhat due to global business investment being in a “on-hold” mode pending some settlement of the trade squabbles between China and the US.

Our exports continued to expand at a strong clip in the first part of 2019 with increased volumes and prices.

When overall GDP growth figures for the March quarter are released on 20 June, the growth momentum may surprise on the upside with an increase above 0.6% for the quarter now quite likely.

Back in September 2018, it was a much stronger than expected +1.0% increase in GDP growth in the June 2018 quarter that reversed the Kiwi dollar upwards from rates below 0.6500 at the time.

Global economic and financial markets conditions in late 2018 were arguably much more uncertain than they are today. The share markets were plummeting due to the US Federal Reserve increasing their interest rates and the trade war was fully underway.

In contrast, the international environment today is only clouded by the blow-up in trade talks between the US and China over the last two weeks. Commodity prices are much higher today than in late 2018.

China US trade negotiations remain pivotal

For the Kiwi dollar to make more meaningful gains to 0.6600 and 0.6700, it will require a positive catalyst, such as the China and US trade negotiators getting back around the table again.

There are no signs of that happening in the short-term as the Chinese seem prepared to play the long game in response to President Trump’s taunts, threats and bullying tactics.

Despite the current stand-off and deteriorating relationship between China and the US, both parties know that there is too much at stake for the global economy not to reach some form of agreement on trade.

Trump cannot afford a full-blown trade war that lowers global growth, which in turn is negative for the US economy. He needs a strong US economy going into the 2020 Presidential elections to get re-elected.

A global economy heading into recession due to trade wars is bad news for the Chinese economy as well. Any signs of the trade talks being re-ignited over coming weeks will be reflected in rising equity markets and, in turn, appreciation in the NZD and AUD.

Upcoming interest rate cuts already priced-in to the AUD/USD exchange rate

The Aussie dollar was predicted to recover strongly against the USD on the unexpected Liberal Coalition victory on Saturday 19th May. However, the AUD gains were short-lived as their RBA Governor rather surprisingly lowered their official interest rates in a speech in Brisbane last week.

Identical to the NZ dollar situation with interest rate changes, the AUD/USD forex market has now fully priced-in (in advance) any future interest rate reductions, therefore AUD selling is not anticipated when the interest rates cuts are formally announced.

Inflation dissected?

Both RBNZ economists and private sector economists have highlighted the fact in recent years that New Zealand’s annual inflation rate has consistently tracked below the 2% target and thus lower interest rates are justified and required to boost the economy to generate higher inflation.

The persistent low inflation has only come about due to a global phenomenon that has occurred over the last decade, being the technology revolution. Technological advances in manufacturing and ways of doing stuff has consistently lowered prices for electronic equipment/devices, communications and household appliances.

Analysis of the component parts of the New Zealand Consumer Price Index over the last 10 years confirms that many other price increases households have been paying have been disguised by the massive price reductions (due to the technology revolution) in a small number of items: -

Unfortunately, the technology revolution has not stopped price increases in the 78% staples part, maybe due to a lack of competition and/or inefficient state provision.

Lower socio-economic groups in our community who do not have the discretionary spending cash to buy the latest whizz-bang electronic stuff are not experiencing any benefits of the so-called low inflation. Their household staple expenses have been increasing at 2.8% per annum on average.

The dangers of continually slashing interest rates in response to the very low inflation is that speculative asset bubbles are created in property and equity markets as it is very cheap to borrow.

Under this scenario the gap between rich and poor will continue to widen.

Other losers are elderly investors who are now receiving less than 3.00% return in bank deposits and are being forced into dividend stocks (with attached equity market risks) to earn enough money to live on.

Running a super-loose monetary policy, due to the low inflation the technology revolution has created, is producing a few risks and adverse consequences that do not seem to be well understood. 

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*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981. 

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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21 Comments

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fascinating and a great insight. Although perhaps alcohol and cigarettes should be in the discretionary column!

Outrageous! Addictive substances are staples.

The sad reality is that many people prioritise tobacco over everything. For those people, many in the lower socioeconomic classes, the substance has zero price elasticity. In that respect tobacco is more of a staple that bread.

So we may be unnecessarily lowering rates and creating asset bubbles?

Surely those in charge of interest rates would be aware of such a breakdown...?

Those in charge of interest rates own all the assets. And don't care if bread/milk/veges goes through the roof, they can afford those at any price when their assets go up at 10% a year.

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Housing, healthcare and education are way up but no worries, phones are pretty cheap now. Better try and create *even more* inflation to prop up overpriced assets because that's near all that's counted for growth this last decade. What a dismal failure

Interesting - Lines up with what a lot of people have been saying which is costs of living (needs) are increasing, while overall inflation is low.

I would go further to suggest that inflation is linked more directly to income/expenditure of the consumer

No spare cash = no inflation - as most discretionary spending has a lot more elasticity in it's price. So the prices on the bigger discretionary items drops faster and lower due to low demand.

It's free market competition at its finest. A TV manufacturer believes their competition is a different "Brand" of TV. When actually they are competiting with everything that makes up discretionary spending. Booze, Sports, Phone, holiday, etc....

CPI is up 17 percent over the ten year period .If the CPI was to reflect the RBNZ of a 2 percent rise, the CPI should have increased as a matter of course some 21 percent. http://archive.stats.govt.nz/datavisualisation/cpi.html#160 . Alcohol and cigarettes which surely cannot be described as staples , unless Mr Kerr finds it necessary or helpful to partake regularly ,see that cigarettes have actually risen 189 percent in the period referred to. Using this categories rise to average across all sectors is misleading given its weighting. Food which accounts for a much larger part of the basket falls well below the average CPI rise. Stats NZ will adjust how rents are calculated , commencing this quarter, .How that alters the CPI will be of note. Rents which have a large weighting have "only" risen 23 percent during the 10 year period. Interests charts show the median , albeit not average rent across New Zealand have risen 50 percent. If there has been an anomaly in how the rental index has been calculated , it will soon be uncovered. Undoubtedly we have a domestic housing bubble, the RBNZ has cut ,and will cut again to prevent Auckland house prices from declining, which will come at the expense of FHB .The pricing of our currency, ditto exports or anything else is not the focus of the current RBNZ. Supporting the flailing housing market of our nations largest region, and by extension 4 large offshore banks is all that matters .

Others have concerns over the veracity of CPI calculations in the US - The CPI Is Underrepresenting Food Inflation By 40%: Here's The Proof

Great article thankyou Roger

Wow that table is quite extraordinary . You can debate what's in the categories but the Gap and effect is just too great.

Great chart Roger, I note the 23% weighting for housing and utilities which should be doubled at least.

13
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The other thing about how the CPI fudges things is that as prices rise for certain products, they substitute them for cheaper ones, thus keeping the overall basket of goods the same price, but the quantity / quality of what is in the basket is actually declining. Which means that if you as a consumer *don't* substitute for the cheaper goods, then the CPI figure does not represent your spending - an old guy in my team at work does not eat chicken, only beef and lamb, and so I can't imagine what his grocery budget must be since chicken is now the #1 meat in NZ due to its cheap price.

Similarly with some technology items, over time they substitute better quality products at the same price point, so the price might stay the same, but what you get for that price is better, and so that counts as deflation.

Like if I used to pay $80/month for 100GB of internet bandwidth, and now I pay $80/month for unlimited internet, that gets counted as deflation, even though I'm paying the same amount of money each month and a new $60/month option for 100GB of bandwidth has not been created, so I couldn't save the money by downgrading to the cheaper plan even if I wanted to.

'In contrast, the international environment today is only clouded by the blow-up in trade talks between the US and China over the last two weeks.'

'only'....

This certainly supports imported inflation but I question the balance within the CPI given some of the very large increases. Perhaps we should experiment with increasing interest rates and zero or negative CPI inflation. Although our rockstar economy might crumble and collapse if we do that, almost like the whole thing is an illusion.

How is clothing 'discretionary', and alcohol (including cigarettes) 'staple'?

Roger just put it there as a trap to see how many drunk nudists there are.

Great article Roger, I admit I don't always agree with your views but this article is spot on! Well done

Wrong as usual....peak oil ie expensive energy is the root cause. Now it is the only life support that is keeping the game of musical chairs going.

Great article & posts people. It's hard being perfect as Roger no doubt understands. This is why interest.co is the best news website in the country - because the articles always uncover the opposites (posts) which make for very enlightening reading, I must say. I think I laugh (& learn) more reading interest.co than I do chatting with my wife. Good evening all. It's cold.

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