For the sake of its credibility the Reserve Bank needs to see some meaningful easing in domestic inflationary pressures when the latest Consumers Price Index figures are released in the coming week

It might have felt like every inflation figure released for the past two years was a "crunch” one, but the September quarter figures due out in the coming week REALLY DO loom as a massive test of the Reserve Bank's credibility.

The Reserve Bank (RBNZ) is, remember, charged with keeping inflation as measured by the Consumers Price Index (CPI) within a 1% to 3% range,  explicitly targeting 2%.

However, since the annual rate of inflation rocketed from 1.5% in the March quarter 2021 up to 3.3% in June 2021 it has been a long way outside of the target range - for well over two years now. The RBNZ has slammed us with high interest rates in order to take the heat out of the economy and inflation. Battle has been joined, but it is not yet definitively clear that the RBNZ is winning.

The CPI hit a 32-year high of 7.3% in June 2022 and has subsequently fallen only gradually. As of June 2023, the most recent figure, the annual rate was 6.0%.

If you look around the world, inflation has taken a lot longer to get under control than central banks and economists everywhere predicted. At every step of the way it has proven more stubborn than expected and hoped.

Just as an example of that, in its August 2022 Monetary Policy Statement, the RBNZ had forecast the annual rate of inflation would by June 2023 be down to 4.5%. Well, as stated above, the actual figure was 6.0%. And apologies to the RBNZ if it appears mean to pick that out, but I use it merely as an example. I'm sure if we looked back through all the forecasts made by various economists at the time we could some who missed the mark by even more.

I use the above example because economists' forecasts are now picking a relatively swift decline in the inflation rate over the next year. 

So, eyes forward and on to the CPI for the September 2023 quarter due to be released on Tuesday, October 17.

We know in advance there's a few curly things to look out for in this one. The 25c fuel excise duty cut was reversed again at the end of June - so that will have an impact. And fuel prices have been surging again anyway. So, that will have an impact.

The RBNZ as of its August 2023 Monetary Policy Statement was forecasting the annual inflation figure will be 6.0%, IE exactly the same as it was in June. 

I just had two major bank economists' final forecasts in front of me before completing this article (Westpac 5.8%, ANZ 6.1%) but these two picks do seem indicative of a general range of thinking among other economists of between about 5.8% and 6.1%.

Composition key

The next thing I'm going to say appears contrary. If the final figure comes out under 6% that's not necessarily 'good' news. Likewise if the figure comes out over 6% it's not necessarily 'bad' news. 

I say this because whatever the 'headline' figure, it is the composition of it that will be the crucial thing.

The 'headline' CPI figure is made up of 'tradable' inflation imported from overseas (think fuel, for example) and 'non-tradable' domestically-generated inflation.

Through the Official Cash Rate, currently at 5.50%, the RBNZ essentially targets domestic inflation, since it can't do a whole lot about the price that has to be paid for imported goods such as fuel.

So, it is the domestic inflation that is vitally important - and that's what's looked particularly problematic of late.

According to the June 2023 CPI figures, at that time our 'non-tradable', domestic inflation annual rate was 6.6%, while the 'tradable', imported inflation was 5.2%.

In fact our annual rate of domestic inflation has now been at 6.3% or higher for five whole consecutive quarters. That's a problem. 'Sticky', the economists call it. Ingrained is perhaps another way to look at it.

The RBNZ is forecasting that domestic generated inflation will have dropped to an annual rate of 6.2% as of the September quarter.  

If the RBNZ has a significant 'miss' on this, IE its forecast undershoots the actual domestic figure, then, trouble. 

The September quarter is supposed to signal the beginning of a significant rate of decline in that domestically generated inflation, with the RBNZ forecasting that the non-tradable rate will fall rapidly to 5.5% by December 2023 and then, looking out a year, be down to 3.3% by September 2024. 

Okay, so what if domestic inflation doesn't play ball?

Well, there's only one thing for it. The RBNZ would have to raise that OCR again. Mortgage rates would likely be on the way up again and the whole 'higher for longer' idea would start to develop into 'higher for EVEN longer'.  

The next OCR review for the RBNZ on November 29 is the last one for for this year - and for three whole months. If domestic inflation is not looking under control when the RBNZ's Monetary Policy Committee sits down to deliberate on November 29, they will hike again. They will have to. A hike for Christmas. Surely, it would be too long to wait till late February.

So, what, numerically would be a 'bad outcome' for domestic inflation in those September quarter figures?

Well, the RBNZ's forecasting a 6.2% annual rate, down from 6.6%. Okay, so, if the actual figure came in at 6.3%, well, that would be moving in the right direction, the RBNZ can live with that. How about 6.4%? Not so good. In that case the RBNZ's decision whether to hike or not to hike would possibly hinge on the labour market figures being released on November 1. If it's 6.5% then definitely, I think, it's got to be an OCR hike. And 6.6% or worse? Well, disaster really.

But hey, let's all take some happy pills. If it is 6.2% or even lower then fabulous. Very pleasant surprise. We are on the right track. Very probably we can presume the OCR will stay 'on hold' for the foreseeable future. 

Is it really all just about the domestic inflation figure though? Well, yes, pretty much - with one slight qualification. In terms of the 'tradable' imported inflation figure for the September quarter, the RBNZ is picking that it will have risen from the previous 5.2% to 5.8% and that's the reason why the 'headline' inflation rate is expected to stay at 6.0% as it was for the June quarter.

If the imported inflation figure does turn out far worse than expected and we see it blow out that headline inflation figure to above 6%, well, it's definitely not a good look for the RBNZ - but the central bank would be able to 'look through' the imported inflation elements in the overall figure and leave the OCR on hold. A major concern though would be if the country's price setters are spooked by that still very high 6%+ figure and start raising their prices again in reaction. That would be the dreaded 'inflationary expectations' starting again to fuel real inflation. But that's probably something the RBNZ would need to deal with in the New Year.

Anyway, the upshot is that much rides on these CPI figures. This is crunch time. We need to see signs that inflation is moderating. Otherwise the RBNZ will need a rethink. And a rethink would mean higher for longer interest rates.

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