By Alex Tarrant
New Zealand households are facing 21-year high inflation as rising transport, food and housing prices combined with last year’s GST increase to push annual inflation to 5.3% in the year to June, above market expectations, figures released by Statistics New Zealand show.
Markets had been expecting 5.1% annual inflation, as measured by Stats NZ’s consumer price index (CPI). Quarterly inflation of 1% in the three months to June 30 was above expectations for a 0.8% rise, building on rises of 0.8% in the March quarter, 2.3% in December, and 1.1% in the September quarter last year.
The figures have economists scrambling for when they now think the Reserve Bank will raise interest rates, with expectations for a December hike firming. The strongest comment today was from BNZ economist Stephen Toplis, who said the Reserve Bank should raise the Official Cash Rate by 50 basis points next Thursday. See all economist reactions below.
The New Zealand dollar initially rose to 84.88 USc from 84.45 USc before the data.
The annual rise was the highest since a
7.3% 7.6% rise in the year to June 1990, which was also on the back of a GST hike. (Update: At the press conference this morning Statistics New Zealand advised the June 1990 rate was 7.3%, and have corrected their statement to 7.6%.)
The upside figures closely follow on the heels of another upward surprise – GDP figures last week came in well above expectations, pushing the New Zealand dollar up to a fresh post-float high of 85 US cents.
The high New Zealand dollar has been taking some pressure off Reserve Bank Governor Alan Bollard and the need to raise interest rates, as it acts as a softening factor for the prices of imported goods, such as petrol.
are had been tipping the Reserve Bank would hold the Official Cash Rate at 2.5% until at least December, although if economic data releases continue to come in on the upside of expectations, talk of an October rate hike should start appearing in bank economist analyses. (Update: And it has - see reaction section below.)
The RBNZ is charged with keeping the CPI between a target band of 1-3% over the medium-term, and is allowed to look through short-term price effects such as the GST hike from 12.5% to 15% on October 1 last year, which added about 2.22% to general prices.
However, Stats NZ said if GST had remained at 12.5%, the CPI would have risen about 3.3% in the year to the June quarter, suggesting strong upward pressure on prices regardless of the GST hike.
The RBNZ is itself forecasting annual March-year inflation to drop to 2% in 2012 once the effect of the GST hike falls out of the figures, before rising slightly to 2.2% in 2013 and 2.3% in 2014.
The government’s budget documents show Treasury is expecting inflation to fall to 3.1% in the year to March 2012, before falling into the Reserve Bank’s target band with 2.4% expected in the year to March 2013, and 2.5% in the year to March 2014. Treasury correctly picked today's figures in its Budget documents.
The 1% percent quarterly increase in the CPI reflected higher prices for petrol, food, air travel, and electricity, Statistics NZ's prices manager Chris Pike said in a release.
The transport group rose 2.7% in the June 2011 quarter, with higher prices for petrol (up 4.0%), international air fares (up 6.8%), and domestic air fares (up 8.0%).
"Petrol prices reached a new peak in early May 2011 – slightly above their peak in July 2008 – before decreasing later in May and June," Pike said.
Food prices rose 1.1% in the June 2011 quarter, with higher prices for grocery food (up 1.5%) and vegetables (up 6.7%). Significant individual upward contributions came from seasonally higher prices for tomatoes (up 63.6%) and lettuce (up 30.1%). The tomato price rise also reflected a supply shortage caused by the January floods in Queensland, Pike said.
The housing and household utilities group rose 0.9%, with prices for electricity up 2.7%, purchase of new housing up 0.9%, and rentals for housing up 0.5%.
The price rise for purchasing new housing was influenced by rises in Canterbury and in the rest of the South Island, Pike said. The rise in rentals pricing was influenced mainly by rent increases in the Auckland market.
Significant upward contributions in the year to the June 2011 quarter came from higher prices for transport (up 11%), food (up 7%), and housing and household utilities (up 4.4%), Stats NZ said.
Petrol prices increased 20.1%, cigarette and tobacco prices were up 16%, and electricity prices rose 7.8%.
The CPI measures the rate of price change of goods and services purchased by households. Statistics NZ visits 3,000 shops around New Zealand to collect prices for the CPI and check product sizes and features.
80% chance of October rate hike
Westpac chief economist Dominick Stephens and senior economist Mike Gordon said interest rate markets were now pricing in an 80% chance of a rate hike in October. It was increasingly likely annual inflation would still be above 3% at the end of this year when the increases in GST and excises taxes had left the equation, they said.
The June quarter CPI saw the expected contribution from strong world commodity prices. Food prices rose 1.1% for the quarter, while higher oil prices drove a 4% rise in petrol and sharp increases in airfares (domestic 8.0%, international 6.8%, and package holidays 1.9%).
What surprised us was the extent of price increases in other internationally-traded items: household contents rose 1.4%, while recreation and culture rose 0.4% (these include a number of imported and import-competing items). However, these segments tend to be more volatile and are a frequent source of CPI forecasting errors (and they surprised on the downside in Q1), so the stronger than expected outturn should not be overinterpreted.
Non-tradable inflation, which tends to be more stable and persistent, was slightly weaker than we expected (but ahead of the RBNZ's forecast). Housing-related cost pressures were mixed: property maintenance materials rose less than expected (0.5%), but home ownership (the cost of building/purchasing a new home) rose by 0.9%.
The RBNZ was already braced for an annual inflation rate starting with 5, due to a range of policy-imposed cost increases over the last year (GST, tobacco excise, ETS). However, it's increasingly likely that annual inflation will still be above 3% by the end of this year when most of those charges will have dropped out of the equation. The RBNZ has made a crucial assumption that inflation expectations will ease back to within the 1-3% target band, something that becomes less likely when observed inflation remains so high.
The NZD rose 30pts to 0.8480 and the two-year swap rate rose 8bps to 3.50%. Interest rates markets are now pricing an 80% chance of an OCR hike in October. While we think that would be justified by domestic conditions, the sovereign debt woes in the northern hemisphere and the slowing Australian economy present the biggest question marks.
ASB economist Christina Leung said the surprise for them came from the tradable inflation figures, with it appearing evident businesses were acting on higher pricing intentions. An OCR increase this year was now very likely.
The 1.0% increase in the Q2 CPI was stronger than our, the RBNZ, and market expectations. The upside surprise for us mainly came through in tradable inflation, which increased 1.5%. Beyond the expected increase in food and petrol prices, there are signs improved demand is allowing retailers to recoup some operating margins in price of imported household items. This was particularly evident in the price increases in clothing and footwear, and household contents over Q2. The result is in line with recent business surveys pointing to higher pricing intentions, despite an easing in expectations of cost increases in the coming months.
The 0.6% increase in non-tradable inflation was in line with our expectations, and suggest that domestic inflation pressures are contained for now. Nonetheless, there are some areas of concern, with construction cost inflation recording a reasonably robust 0.9% increase in Q2. Stats NZ noted the increase was concentrated in the South Island, and this suggests post-earthquake rebuilding activity is beginning to flow through to a recovery in construction cost inflation. We expect construction cost inflation to accelerate over 2012 as rebuilding activity gathers momentum.
Reflecting the effects of improved demand, there was a wider distribution in price increases over Q2 as less discounting took place. 52.3% of items in the CPI basket went up in price over Q2, higher than the 49.0% in the previous quarter.
Today’s result reinforces our expectations the RBNZ will raise the OCR in December, having brought forward our forecast timing after last week’s strong GDP result. While the stronger than expected increase for Q2 suggests inflation is not as benign as the RBNZ would like, the 0.6% increase in non-tradable inflation indicates inflation pressures in the NZ economy are contained for now. Recent business surveys also indicate little sign of capacity pressures at the moment, with costs and firms’ capacity utilisation both easing slightly over Q2.
Nonetheless, there are areas worth keeping an eye on. Construction cost inflation shows signs of picking up as rebuilding activity gets underway. The RBNZ has highlighted this is one area of inflation pressure it will be leaning against given expectations construction cost inflation will be persistent.
In addition, there has been an increase in pricing intentions and medium-term expectations. These developments will make the RBNZ less comfortable with how inflation pressures are evolving in the NZ economy and, combined with signs of strengthening economic recovery, make an OCR increase this year very likely.
JP Morgan economist Helen Kevans said although they were still picking a March 2012 rate hike, the latest figures meant JP Morgan would review its call, with the Reserve Bank's OCR statement next Thursday holding the key.
RBNZ officials likely are becoming increasing uncomfortable with the inflationary backdrop. The CPI numbers today were highly anticipated following the upside surprise in the growth numbers last week, which showed the economy grew at a solid rate of 0.8%q/q in the earthquake-hit March quarter. Furthermore, not only was the RBNZ looking for consumer prices to rise at a slower rate of 0.7%q/q in 2Q, but the trimmed inflation measures also were much stronger over the quarter (rising from 0.5%q/q to 0.8%), and two-year ahead inflation expectations recently have risen.
Based on domestic conditions alone, the chances of a rate hike in New Zealand before year-end have increased markedly in recent weeks, meaning that our rate call (for the next hike to be delivered in March) is under review.
But, although the run of data signals that the economy may not require the highly stimulatory policy settings currently in place for as long as we currently expect, we are reluctant at this point to bring forward our call for the next rate move for three key reasons.
Firstly, the RBNZ has made clear that it will not remove the current policy accommodation in place until there is clear evidence that the reconstruction phase is underway, which we think will be a late-2011 or 2012 story. We look to see if this sentiment is maintained at next week’s OCR announcement. Secondly, we currently await the outcome of the political gridlock around fiscal policy in the US and Euro area, given that the inability of officials to come to any conclusions on fiscal policy continues to cause significant instability and uncertainty in financial markets.
And, thirdly, NZD strength, which is offsetting to some extent the stimulatory level of monetary policy settings, also buys the RBNZ more time to assess how things pan out offshore.
Awkward starting point for upswing
HSBC chief economist for Australia and New Zealand Paul Bloxham said having inflation above or in the top part of the RBNZ's band was an awkward starting point for an economic upswing.
The New Zealand economy is recovering from an extended period of economic malaise and today's CPI report suggests inflationary pressures are also building.
Across a range of metrics it looks as though inflation is now running at an uncomfortably high level.
To start with, headline inflation is 5.3% over the year, which is well above the RBNZ's target band of 1-3%. Of course we know that it has been boosted by the effect of tax changes last year, but Statistics New Zealand has told us that when they abstract from those changes, headline inflation is still running at 3.3%, which is above the target band.
Besides, the Q2 results, in and of themselves, are not affected by last October's GST increase, and headline inflation rose by 1.0% in Q2, which is well above the target band in annualised terms (4.1%). The argument, put by some, that the GST change may have had some effect on the Q1 numbers, as well as obviously impacting Q4 2010, does not really hold for Q2 2011.
Digging a little deeper, the non-tradables component of the CPI, which is a better reflection of domestic inflationary pressures, is running well above the target band y-o-y at 5.2%. Even on a quarterly basis the non-tradables component is sitting in the upper part of the target zone at 0.6% q-o-q (which is 2.4% annualised). Q2 is also a seasonally weak quarter for non-tradables inflation, so we'd typically expect a rise in Q3.
Tradables inflation is very strong, on the back of oil price rises earlier in the year, running at 1.5% q-o-q and 5.5% y-o-y. Of course, we expect pressure on tradables to ease in coming months as oil prices have come down and the NZ dollar has strengthened (up around 12% against the USD since its trough in mid-March).
Inflationary expectations have also been high recently, with two-year ahead surveyed expectations at the top of the RBNZ's target band, at 3%.
All in all, inflation is above, or in the upper part, of the target band on a large range of metrics. This is an awkward starting point for an upswing in an economy.
The key question will be, how convinced is the RBNZ that a strong upswing is now in train? On this, they may have some lingering concerns that some weakness from the Canterbury earthquake will still show up in the Q2 indicators. They will also be watching the world, particularly Europe, very carefully at moment, given New Zealand's large overseas funding requirement. These factors may keep them on hold for a bit longer, but with a recovery in swing and inflationary pressures building, we expect a reversal of emergency rate settings to be on the cards soon.
Inflation remains above the RBNZ's target zone.
We expect the RBNZ to reverse its emergency settings soon, with Q4 our central case, though the risk is for an earlier move.
RBNZ should hike now
BNZ's Stephen Toplis said based on the current evidence, the Reserve Bank should raise the Official Cash Rate at its next announcement next Thursday. However, Toplis added although that was what the RBNZ should do, he was still picking the first rate hike in December, but only just.
And thank goodness for the strength in the NZD, imagine where inflation might now be had the NZD not appreciated as aggressively as it has. Which, of course, begs the question as to how much more we can rely on the currency doing all the work to contain inflation instead of domestic interest rates also playing their part?
With this in mind we will, of course, be watching the July 28 OCR review with great interest. Yet again we find ourselves in the unenviable position of forecasting what the central bank WILL do as opposed to what we think it SHOULD do.
In our opinion, the only right thing to do would be to raise the cash rate by 50 basis points based purely and simply on the Bank sticking to a consistent story. The only reason that the cash rate currently sits at 2.5% is because the central bank implemented an “emergency” easing immediately following the Christchurch earthquake of February 22.
The intention was to protect against a slump in confidence and, in turn, economic activity. We argued against the cut at the time and we believe that our stance has been vindicated. The drop in confidence was very short-lived and nearly every economic indicator that has been printed over the last month or so has indicated that the economy is getting back on its feet again. The latest of such indicators was this morning’s PSI, which at 54.7 represents a fairly solid performance from the services sector. On the basis of this and the many other solid growth indicators, both concurrent and forward-looking, there is no reason whatsoever for the “emergency” assistance to remain in place.
But do we believe the central bank will be consistent? Alas, no. We suspect it will puddle along in no-man’s land in acknowledging the stronger than expected domestic indicators but also doffing its hat to heightened global risk as the reason to remain immobile.
Be that as it may, we also believe the power of the market will eventually hold sway. The more aggressive the market becomes with its desire to see an earlier Bank response the more likely that response will be forthcoming. For now we’ll stick with our December call but only just. It’s now a 50/50 pick between December and earlier. Furthermore, it’s also a 50/50 call on 50 or 25 for that first move. And, we repeat, it’s not that today’s CPI has changed our view of the world very much at all but more that the market awakening to the inflation risks that lie within this economy has now pushed market pricing to such a degree that the central bank governor can no longer hide behind it.
Prime Minister John Key said the rise in the CPI needed to be put into perspective in the sense part of the rise was due to the GST increase.
“So if we take that out, inflation would be running at about 3.3% - so very slightly above the band," Key told journalists at his weekly post-cabinet press conference.
“What New Zealand’s facing in terms of higher inflation - which is primarily around food, petrol, electricity - that’s not unusual. Pretty much most countries in the world are suffering that at the moment," Key said.
"So our view is the long-term outlook for inflation is one where it comes under control, and if we take out that extraordinary bit then it’s, as I say, above the band, but not dreadfully so," he said.
Asked whether it was worrying that New Zealand had inflation above the band at the beginning of an economic upturn (see HSBC economist Paul Blowham’s comments above), Key replied:
“Well typically the band’s running at 1-3%. Typically it’s always near the top end – that’s not unusual over the span of the way the Reserve Bank governor manages things. We’re in a lot better shape than when we came into office, which was, inflation was running about 5% at the back-end of Labour’s term in 2008, interest rates were ten and a half per cent, and as I say, if you take out the extraordainary one-off adjustment for the tax switch then we’re running at about 3.3%."
“So, a little higher [than the band], but as I say, those factors are prevalent everywhere around the world. You’ve had high oil prices, high food prices, a number of natural disasters and events which have impacted on food [prices] around the world," he said.
Whether there would be increasing pressure on prices as the economy recovered, Key said that depended on what drove inflation.
“If it was wage inflation because of capacity constraints then that’s a different factor to the fact that there’s been floods in Queensland [that have] forced up food prices," he said.
“Internationally, yeah, there is concern about inflation. You’re seeing higher levels of inflation than people would probably like in China and Russia, and other parts of the world. For the most part, as I say, in New Zealand I think we’ve broadly got it under control."
Meanwhile ACT Party leader and former Reserve Bank governor Don Brash used the opportunity to call for government Budget spending cuts. See his comments below:
News that New Zealand’s rate of inflation has hit a 21 year high of 5.3 percent should come as no surprise, according to ACT New Zealand Leader Dr Don Brash.
Under the Reserve Bank Act, the Governor of the Bank is responsible for keeping inflation between one and three percent.
“During my time as Governor of the Reserve Bank, New Zealand and the rest of the western world succeeded in taming this monster, probably in the nick of time,” says Dr Brash.
“Inflation has an especially devastating effect on those on fixed incomes and at lower socio-economic levels. It is a potent destabilising force that can threaten the very future of western civilisation.
“While the new figure is undoubtedly due in part to last year’s GST increase and factors outside our control such as weather induced food shortages, it does underscore the need for governments to refrain from exacerbating it by spending too much and running up irresponsible deficits.
“The renewed spectre of inflation is another reason for voters to give careful consideration to ACT’s economic policies, which include bringing spending under control and achieving a balanced budget as soon as possible,” Dr Brash concludes.
(Updates with reaction from PM Key and ACT leader Brash, BNZ, HSBC, JP Morgan, ASB, Westpac comments, comment Treasury correctly picked today's figures)