Investors in the United States faced a nasty shock this week as fresh data showed economic growth slowing and inflation stalling.
Personal consumption expenditures (PCE), a measure of inflation targeted by the US Federal Reserve, suddenly stepped up to 3.4% in the first quarter of 2024.
This rate peaked at 7.7% in early 2022 and had been below 2.6% for the past three quarters.
At the same time, economic growth tumbled to 1.6% when economists had been expecting something closer to 2.4%.
These are preliminary numbers which will be revised, but they reinforce a gradual realisation that the battle against inflation still hasn’t been won — even in the United States.
Here in New Zealand, market expectations of future interest rates have taken another step closer to the Reserve Bank’s hawkish projections after the Consumers Price Index (CPI) data release last week.
The headline rate was 4% in the March quarter, 0.2 points above the Reserve Bank's forecast, although it has been trending downwards.
Non-tradable, or domestic, inflation landed 0.5 points above the central bank’s forecast at 5.8% with housing costs and cigarette taxes still increasing.
It shouldn’t have changed anyone’s view of the world, BNZ’s head of research Stephen Toplis said, but it did shift market pricing of interest rates.
ANZ analysis showed investors were pricing a full rate cut by October prior to the data release. That has now been pushed back to November, which is when economists also expect a cut.
Market pricing tends to predict earlier cuts than economists’ forecasts as the benefits of being early can outweigh the risks of being wrong.
It also shifts around more than official forecasts do. At the end of 2023, traders were positioned for the first rate cut to occur this May — which no longer seems plausible.
Adrian Orr, Governor of the Reserve Bank, has repeatedly warned that getting inflation from over 7% to under 4% would be the easy part, and the “last five yards” would be harder.
New Zealand is now in those final five yards. Statistics NZ’s measure of core inflation, the trimmed mean, suggests prices have risen about 1.5% over the past six months.
That would mean an annual rate of about 3% in the September 2024 quarter, and a headline rate of 2.2%, if prices simply continued to increase at the rate seen in the past six months.
One might expect the central bank, once back in its target band, to cut rates quickly, especially as monetary policy changes can take 18-months to fully be felt in the economy.
The experience in the US shows that inflation can bounce out of the target band and the Reserve Bank wants it back at the 2% midpoint. That’s one reason to be cautious, but there are others.
One is that it is not clear exactly how much current interest rates are restricting the economy.
A recent bulletin published by the Reserve Bank reviewed its estimates of the neutral interest rate and found a significant difference between long and short term rates.
It said the short-term nominal rate was most useful for thinking about whether the Official Cash Rate, currently 5.5%, was contractionary in the current period.
The mean estimate for the short-term rate was 3.9%, compared to the more-often cited long-term neutral rate which was 2.6%. Both have been rising after decades of decline prior to the pandemic.
Some analysts wonder whether the world has left behind an era of falling interest rates and is moving into a period of increased inflation risk.
Morrison’s Paul Newfield, the chief executive of a large investment firm, recently told Interest.co.nz he was not predicting a return to ultra-low interest rates.
A big reason for this was because the world was attempting to de-globalise and various countries were willing to pay extra to bring strategic industries closer to home.
“We all need to be realistic that the idea that the world’s on its way towards a global free market is a relic of the past,” he said.
“Fundamentally, trade restrictions will always be inflationary which is one of the reasons we’ve been wary of predicting a rapid decline in global interest rates”.
Shifting away from fossil fuels will be another long-term inflation pressure, even if renewable energy and low-carbon alternatives work out cheaper in the long run.
As an example, Air New Zealand recently announced it would buy nine million litres of sustainable aviation fuel three or four times the cost of regular jet fuel.
Singapore and the European Union have begun to require flights departing from their airports to use a minimum amount of sustainable fuel. Ticket prices will rise if costs don’t scale down.
This is just one example of how reducing emissions could push up costs. If central banks want to hold inflation at 2% then other prices in these economies will need to be restrained.
Kiwis already expect inflation to be a little on the high-side. Two-year inflation expectations were at 2.5% in a March survey, while 10-year expectations were also slightly elevated at 2.2%.
While the inflation wildfire sparked by the pandemic has almost been tamed, conditions in the global economic forest are forecast to be hot and dry for the foreseeable future.
We welcome your comments below. If you are not already registered, please register to comment
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.