David Hargreaves assesses prospects for the September quarter CPI figures to be released this coming Wednesday, which should show inflation back under 3%. But could the figures still put a dampener on expectation of further fast interest rate falls?

A lot still rides on the next set of inflation figures to be released in the coming week.

And yes, that's the case even though the Reserve Bank (RBNZ) effectively declared victory against the inflation beast when making a double-cut to the Official Cash Rate (OCR) on Wednesday, October 9.

The RBNZ did all this of course before being in receipt of the latest official inflation figures. The figures for the September quarter, as measured by the Consumers Price Index (CPI), are due to be released by Statistics NZ on Wednesday, October 9.

As we might imagine from the RBNZ's confidence, the CPI figures are expected to be 'good'. But how good? More to the point - will they be 'good enough' in the fine detail for the RBNZ? It's some of the detail in the figures that could yet have a significant impact on the future path of the OCR and particularly the speed of future cuts.

And so while the RBNZ has now started to reduce interest rates, in the expectation that inflation has been 'tamed', our central bank will nevertheless want to see the firm evidence that inflation really is on the run. In some aspects, I certainly think there's still more evidence needed, particularly in regard to the sustainability of low rates of inflation.

To some extent the RBNZ has arguably claimed victory in expectation of inflation drops - rather than necessarily seeing the hard details. The figures coming out on Wednesday are the first official CPI figures since the RBNZ began cutting the OCR, with the previous CPI figures for the June quarter having been released in July.

So far the RBNZ has already, since August, dropped the OCR by 75 basis points from the 5.50% peak to 4.75% currently.

The market wants action

The 'market' wants to see the OCR cut very quickly from its recent highs and is egging the RBNZ on - but if the actual rate of inflation disappoints, then the RBNZ may yet not move rates in quite the way the market anticipates. And the market could be disappointed.

Following the October 9 OCR cuts the financial markets were fully pricing in another 50 bps of cuts in the final OCR review for the year on November 27, while there's seen as a 50-50 chance that the first OCR decision of 2025 in late February will also be a double-cut.

So, those inflation figures...

The June quarter 2024 CPI figures, released in July, showed the rate of annual inflation slowing to 3.3% from 4.0% in the March quarter.

It's universally expected that the September quarter figures are going to show an annual inflation figure of under 3%.

This means that we'll have an inflation rate inside the 1% to 3% target for the first time since the March quarter of 2021. It's been a long time. Remember that in June 2022 the annual inflation rate actually got as high as 7.3% and it made its way back down only slowly at first. (The graphs with this article are sourced from the RBNZ's August Monetary Policy Statement).

In its August Monetary Policy Statement (MPS) the RBNZ forecast that the September quarter CPI would show annual inflation falling to 2.3%. 

Recent second-tier economic data, including the monthly Selected Price Indexes containing items that make up about 45% of the CPI, have suggested that 2.3% could indeed be about where the CPI reading will land, and maybe even lower. If the actual figure does come in at that level it means we won't be far off getting to the 2.0% figure the RBNZ explicitly targets achieving within that 1% to 3% range. 

So does this mean it is all go for more OCR cuts then?

Well, yes. But the pace of the cuts could still be affected. 

There's three ways this can all go when the CPI figures are released on Wednesday:

1. The CPI figures are about what was expected so the RBNZ proceeds with cutting the OCR at its own pace - which likely will indeed include at least one more 50 basis point cut, in the final OCR review for the year late next month.

2. The CPI figures are lower than expected, opening up the prospect for even more rapid-fire OCR cuts. The financial markets are ALL FOR this scenario, in which perhaps we could see the OCR chopped back to just 3.75% by February 2025.

3. The CPI figures 'surprise on the upside'. This would be the proverbial spanner in the works. It's not the expected scenario. But then, spanners in the works are never expected.

The composition of the inflation figures will be important.

In its August MPS forecasts the RBNZ was picking that the annual rate of overseas-generated, so-called 'tradables' inflation (think things like oil prices) would be -1.6%. So, we are expected to be getting a great helping hand from reductions in the cost of overseas goods. This is actually not so untypical of what we saw at times in the pre-Covid period, when we were often importing DEFLATION. Very handy.

However, we do know that domestically-generated, so-called 'non-tradables' inflation has been much slower to fall. And this is the one that the RBNZ worries about - because this is the figure it can do something to influence through its use of the OCR.

So, the RBNZ's pick for the annual rate of non-tradables inflation as of the September quarter was 5.1%, down from 5.4% in the June quarter. The figure's expected to be still elevated, but finally coming down.

The RBNZ's obviously getting comfort from the fact that falling overseas-sourced inflation is dropping so much. But it DOES need to see definitive evidence that domestic inflation pressures are easing.

It's fair to say there's a lot of anecdotal evidence to suggest that domestic inflation is about to collapse, but it's not yet made its way into the official figures - which is why this coming Wednesday's figures are so important.

On the anecdotal evidence side, two much-watched business opinion surveys came out recently.

The NZIER Quarterly Survey of Business Opinion showed weak pricing pressures among Kiwi businesses. But it's worth mentioning, very worth mentioning, that the pricing intentions measure is just for three months ahead.

ANZ's latest Business Outlook Survey, which likewise painted a gloomy picture of the here and now did show a blip up in expectations of the future - in a 12-month timeframe.

As long as inflation still returns...

As ANZ chief economist Sharon Zollner commented at the time, there is a risk that the economy’s response to lower interest rates could be "more vigorous"  than is generally expected. She said that would be good news - as long as inflation still returns sustainably to target.

Yes, that's right. As long as inflation still returns sustainably to target.

What's the ideal scenario for the RBNZ from the inflation figures out in this coming week, then?

Well, a 'headline' annual inflation rate as close to the targeted 2% 'midpoint' of the 1% to 3% range as possible would be very encouraging. And if that's combined with a 'non-tradables' annual inflation rate of lower than the 5.1% the RBNZ predicted then the CPI figures will indeed be a win-win for the the central bank.

That's all eminently possible.

And if it does pan out like that then we can expect to see the RBNZ continue to aggressively take the OCR down to what's considered a more 'neutral' level, which these days bank economists reckon could be anywhere between about 3% and 4% depending how you calculate 'neutral' and over what timeframe.

What the RBNZ will definitely not want to risk, having put us through a recession in order to tame inflation, is seeing some still-glowing embers of inflation reignite again.

*This article was first published in our email for paying subscribers early on Friday morning. See here for more details and how to subscribe.