Government’s inflation worst case scenario ‘much more closer to the baseline’ - Westpac's Kelly Eckhold says

Treasury's inflation "worst case scenario" from the Middle East conflict is much closer to the baseline, Westpac chief economist Kelly Eckhold says.

Finance Minister Nicola Willis briefed journalists on Monday and said Treasury was forecasting inflation rising higher this year than anticipated. Willis said the worst case scenario, “which is for a prolonged conflict with oil prices continuing to go higher than they are - that is a conflict potentially lasting through the rest of this year”, was 3.7%.

Speaking to Interest.co.nz, Eckhold said he would "not necessarily characterise [Willis'] scenario as worst case, it could increasingly just be base case, depending on how things go in the next week or so".

Eckhold said Westpac's current forecasts had inflation going up to the low threes, "but I wouldn't categorise that as the highest that we think inflation could go".

"The worst case scenario here is probably a bit closer to what we portrayed in our model scenarios last week, where we talked about a three month closure of the Strait of Hormuz, that would be associated with oil prices heading up, perhaps towards US$185 or $200 a barrel.

"I think it would be associated with much wider refined fuel spreads and therefore very high prices at the pump, as well as a restriction in the available supply as well - so we would have to actually start prioritising use for fuel around the country.

"That sort of scenario could deduct quite a bit off GDP. We estimated, perhaps getting towards one percentage point off GDP, but also, crucially, it would push inflation up, perhaps up towards 5%."

He said all the scenarios were "very artificial."

"There's a lot we don't know about exactly what will happen here, but I think it's very dangerous to... use the term 'worst case scenario', because there's quite a lot of variables that we don't know very much about, and particularly if it does get to the point where fuel stocks need to start being prioritised, because that has probably non-linear effects that aren't really just reflected in prices but are actually reflected in activity as well".

Westpac's fuel price forecasting, which Eckhold described as "very fluid right now, to use a pun", looked at where crude oil and refined fuel spreads were, and was consistent with petrol prices at the pump heading to about $3.10 and $3.20 potentially in the next few days, he said.

"We're basically assumed that oil prices remain elevated at around current levels, perhaps for another few months and and then gradually start to tail off as we go through towards the end of the year, into next year.

"We still think that oil prices probably remain elevated through 2027 compared to where they were three weeks ago, but we would expect them to be noticeably lower, perhaps sort of down towards US$80 a barrel next year."

On supply, Eckhold said while there was no particular issue with fuel availability right now, there was no visibility about what would happen post the start of April.

"It is the case that the Asian refiners will have received their last shipments of crude oil from the Middle East before the end of this month. So at that point, they're going to have to basically start scaling back production, which means if you don't produce, if you don't refine product… you can't sell it."

Asked how likely it was that fuel importers would struggle to fill their orders, officials advised Willis moving to any further mitigation measures under the national fuel plan was at least three to four weeks away.

Eckhold said he thought the biggest issue New Zealand faces was the impact of increased diesel and petrol costs on the supply chain. 

"That's going to impact everybody... You will see increased costs being passed through for a whole gamut of things, because just about everything relies on the transport sector to get goods to market."

"The groceries, courier fees, we've already seen airfares go up quite considerably as well," Eckhold said.