'Whatever your point of comparison it seems the worst-case scenario could be a lot worse than Treasury envisages,' BNZ head of research says, as projections see inflation hitting 3.8% and in some cases, pushing past 4%

Treasury's "worst case scenario" of inflation at 3.7% has come under question, as New Zealand fuel prices continue to rise amidst conflict in the Middle East.

BNZ head of research Stephen Toplis says in light of the latest movement in New Zealand fuel prices, it is raising its forward inflation track - projecting consumer price index (CPI) inflation peaking at 3.8% in the June quarter.

As of the December quarter the CPI was recording an annual rate of inflation of 3.1%, which is outside the 1% to 3% target the Reserve Bank (RBNZ) has.

Toplis' comments follow the latest release of the Selected Price Indexes (SPI), a monthly series that features about 47% of the contributors to the quarterly CPI. Food prices make up about 18.5% of the CPI and rent now makes up just over 11% of the CPI so the SPI is a good early guide to what inflation is doing.

Food prices jumped 4.5% in the 12 months to February and outside of food prices, there was a 12.8% monthly hike in domestic airfares.

Following the release of SPI data, Toplis says while the research team isn't changing their inflation expectations for the first quarter (they're projecting 2.9%), "it's thereafter that things get really interesting".

Now projecting a 3.8% peak for the June quarter - up from their previous forecast of 3.6%, Toplis says: "Importantly, it remains above 3.0% in the following two quarters. This will mean inflation will have been predominantly above 3.0% for six consecutive quarters."

The prospect of this feeding into inflation expectations - which are already rising - is high, he says, and this is "nightmare territory for the central bank who had assumed in the February MPS (Monetary Policy Statement) that inflation expectations could fall".

'Seriously questions Treasury's forecasts'

Toplis says: "It also seriously questions Treasury's forecasts that annual inflation will only rise to 3.7% under a worst-case scenario".

"3.8% is our central view. Because of that there is, of course, around a 50% chance that it doesn’t get to 3.8%. But that also means there is an equal chance that it turns out greater than that," he says.

"Our forecasts assume that the average price of 91 grade petrol stays, where it is now, at $3.05 through to the end of April and then falls relatively aggressively.

"To us that seems a relatively conservative view. We also assume that second round effects are well-contained and that the currency does not depreciate rapidly. These are starting to look like fairly heroic assumptions," Toplis says.

"A worst-case scenario in our minds would be a widening of the war in the Middle East accompanied by more disruption to global logistics and a sharply falling New Zealand dollar. The chance of this must be non-negligible and would definitely result in much higher pump prices."

Toplis says it also thinks Treasury's belief that growth of 2.5% is a worst-case scenario for 2026 is overly optimistic.

"Based on the economy growing an average of 0.7% per quarter in that year we end up forecasting annual average growth of only 2.4% as our central forecast or 2.9% if we look at December quarter 2026 relative to December 2025.

"Whatever your point of comparison it seems the worst-case scenario could be a lot worse than Treasury envisages."

A scenario where inflation could push above 4%

If oil prices rise for a six-month period, there's a scenario where we could potentially see inflation push above 4% for much of 2026, ASB senior economist Mark Smith says.

The ASB economics and research team has come up with different inflation scenarios “to illustrate how significant sizable swings in energy prices and transport disruptions could impact New Zealand near-term inflation,” Smith says.

“The key uncertainty is how long the Middle East conflict persists for … The risk is that the Iranian conflict persists for months rather than weeks,” Smith says.

Smith says February’s SPI figures were stronger than its expectations of a solid seasonal fall but also pointed out that this data precedes the Iran conflict, “which has seen an escalation in geopolitical tensions and surging oil and fuel prices”.

“The outlook is incredibly uncertain, but the risk profile is tilted towards a greater skew of downward risks for New Zealand economic activity and employment but with an upward skew of risks to New Zealand inflation.”

Smith says a more prolonged conflict will have more “tangible impacts” to inflation and broader economic activity.

A sustained oil price rise would likely pass through to other costs and local transport, leading to extra CPI impact over time. Alongside this, higher global oil prices and transport disruptions would also put pressure on New Zealand’s import prices.

“This could flow through into a more generalised lift in tradeable goods and services prices.”

But if the conflict is resolved quickly “with little damage to energy infrastructure”, the economic implications “may be modest”, he said.

Scenarios

Using Brent grade oil for its scenarios, Smith says its central scenario sees headline CPI inflation easing to 3% in the first quarter of 2026 but then peaks at 3.5% in the next quarter, before easing back to 3.0% by early 2027.

This central scenario paints a picture where there’s an oil price decline. It sees oil at $100 USD a barrel with the expectation of a drop to $80 USD a barrel.

In another scenario, oil prices spike - with oil prices hitting $130 USD per barrel for a six-month period before prices drop to $80 USD by mid 2027.

“Under this scenario, headline CPI inflation pushes above 4% for much of 2026,” Smith says. This scenario suggests inflation peaks in the third quarter to 4.2% before falling below 3% from mid-2027.

Another scenario sees Brent oil prices sitting at $100 USD per barrel over the next 12 months before gradually dropping towards $80 USD.

“Under this scenario, headline CPI inflation peaks at just under 4% by mid-2026 and falls below 3% from mid-2027.”

Smith says these scenarios only include the direct impact of higher energy prices - not the “second-round impacts that matter for medium-term inflation”.

“Pricing behaviour will depend on whether firms will accommodate the higher costs or pass them onto users,” he says.

“Generally, the more persistent the uplift in energy prices the more likely that we see a flow through into general wage and price setting.”

Smith says it’s keeping close tabs on surveyed pricing intentions and inflation expectations.

What does this mean for the Official Cash Rate?

Smith says the Official Cash Rate (OCR) is still expected to hold at 2.25% for much of this year.

Be he cautions that “the risks are titled towards an earlier start to OCR hikes, with the RBNZ potentially having to lift the OCR above circa 3.25% neutral levels in 2027 if higher near-term inflation looks likely it will seep into broader wage and price setting”.

“It highlights the inflation dilemma facing the RBNZ and the tough hand being dealt to incoming Governor [Anna] Breman.”