Trump’s trade war could cause households to pay attention to inflation again, even as underlying price pressures trend downwards

Annual inflation has landed in the Reserve Bank’s target band for a third consecutive quarter and most economists have stopped fretting about a possible bounceback.

Stats NZ’s consumer price index data release on Thursday morning showed headline inflation rose 0.3 points to 2.5% in the March quarter, while some of the most watched core inflation measures dropped to 2.2%. The RBNZ’s own measure fell from 3.1% to 2.9%, back in the target range for the first time since the spike began.

Miles Workman, a senior economist at ANZ, said the slight upside surprise was driven by the Government’s university fees policy and didn’t suggest growing inflation pressure.

“Looking through some of the more volatile parts of the basket, underlying disinflation appears very much intact … To ensure the recovery remains on track and CPI inflation doesn’t undershoot target in the medium term, we now think a little monetary stimulus will be required,” he wrote in a note.

Other economists agreed, saying inflation was “well contained” and likely to remain within the Reserve Bank’s target band — even if it lingers above 2% for a while.

There is also a growing consensus that Donald Trump’s trade war is likely to be disinflationary for New Zealand, even if it results in higher prices in some other economies.

Tariff trade

US stockmarkets fell on Thursday our time after Federal Reserve chair Jerome Powell said in a speech the tariff policy threatened both halves of its dual mandate: employment and price stability.

“The level of the tariff increases announced so far is significantly larger than anticipated. The same is likely to be true of the economic effects, which will include higher inflation and slower growth,” he said.

If this ‘stagflation’ scenario occurred, the central bank would likely prioritise fighting inflation over supporting the economy and employment — and Powell implied as much.

"We will balance our maximum employment and price-stability mandates, keeping in mind that, without price stability, we cannot achieve the long periods of strong labor market conditions that benefit all Americans,” he said.

Without any new tariffs on the New Zealand border, the likely outcomes of the trade war skew towards lower prices and economic growth. The RBNZ could respond to that scenario by reducing interest rates below the neutral rate—of roughly 3%—it is currently targeting.

In a speech earlier this week, chief economist Paul Conway said it had been hard enough keeping up with the slew of announcements let alone working out what it will mean.

The Monetary Policy Committee had agreed the tariffs would result in less economic activity globally but the impact on inflation was more ambiguous. There was “good scope” to lower the Official Cash Rate further as that impact becomes clearer, he said.

Mary Jo Vergara, a senior economist at Kiwibank, said the central bank ought to cut the benchmark rate from 3.5% today to 2.5% before the end of the year.

“The prospect of a global trade war will likely keep downward pressure on prices. Whether that’s as a consequence of a slowdown in global economic growth or a diversion of trade marked at a discount,” she said.

This is not a universally held view. Some economists, including those on the RBNZ's monetary policy committee, argue that tariffs could raise New Zealand's inflation by disrupting supply chains and weakening its exchange rates.

Attenzione, pickpocket!

Matthew Allman, from Infometrics, said the pressures in the March data may be cause for concern, “particularly with the effects of the ongoing trade war yet to come through”.

Infometrics' latest economic forecast warned of a sharp slowdown in growth next year and suggested rising imported inflation and a weaker exchange rate could prevent the RBNZ from cutting rates in response.

“As a result, we expect the Bank to cut the official cash rate to 3% by July, but any further reductions will be dependent on expectations for lower, more favourable inflation outcomes”.

One problem for policymakers will be that Trump’s trade war could keep inflation in the headlines and prompt consumers to focus more on price increases.

RBNZ research shows households pay more attention to inflation when it is high. This is called “rational inattention” and can make inflation expectations more sticky once the headline rate crosses a certain threshold.

Respondents in the most recent survey of inflation expectations expected inflation in two years’ time to be 2.06%, down from a peak of 3.6% in 2022. This two-year timeframe is the result the RBNZ monitors most closely.

Policymakers will need to watch whether households remain “rationally inattentive,” given inflation has been on target for over a year, or whether talk of tariff-driven price rises grabs their attention again.