By Alex Tarrant
The Reserve Bank may delay hiking the Official Cash Rate until later than March 2013 after weaker-than-expected inflation figures were released this morning, economists say.
Statistics New Zealand said the Consumers Price Index (CPI), a measure of general price levels in the economy, rose 1.0% from the June 2011 quarter to the June 2012 quarter, following a 0.3% rise in the the CPI in the June 2012 quarter from March. That meant annual inflation was right at the bottom end of the central bank's target band.
The latest figures mean annual inflation is now its lowest since a 0.5% rise in the year to the December 1999 quarter. Excluding a 13% rise in tobacco prices over the year – reflecting an excise tax hike – the CPI would have risen 0.6% annually, Stats NZ said.
Economists polled by Reuters gave median expectations of 0.5% quarterly, and 1.1% annual, rises in the CPI.
Lower-than-expected housing-related inflation figures in the June quarter meant Westpac would review its current pick, for rate hikes to start in March 2013, with an eye to a later start, chief economist Dominick Stephens and senior economist Michael Gordon said. They doubted the Reserve Bank would seriously consider cutting the OCR from its current record low of 2.5%.
ASB economists said a contained inflation outlook added to the case for little urgency for the Reserve Bank to raise the OCR, and they expected the RBNZ would keep the OCR on hold "until at least March 2013."
JP Morgan economist Ben Jarman said it continued to forecast the RBNZ to begin raising rates with a 25bp hike in March 2013, "but given the trajectory of the inflation data, the risks now are skewed to a later move."
The Reserve Bank is mandated to keep medium-term annual CPI inflation within a 1% to 3% target band. Its main tool for doing this is by setting the Official Cash Rate – a base rate for interest rates in New Zealand. The OCR is most closely correlated to short-term interest rates like variable (floating) and short-term fixed mortgage rates.
Before today’s figures, bank economists were picking the Reserve Bank would leave the OCR on hold until March 2013 due to a bumpy local recovery and a volatile global economy. Financial markets were pricing in a 13% chance of a 25 basis point cut basis points of cuts at the Reserve Bank’s next OCR decision on July 26, and that the OCR would be 17 basis points lower in a year’s time.
Electricity prices hit new peak
The 0.3% quarterly rise in the CPI followed a 0.5% rise in the March quarter and a 0.3% fall in the December 2011 quarter, Stats NZ said.
The key individual upward contribution to the CPI during the quarter was electricity prices (up 4.5%), while vegetable prices were up 11%, largely influenced by a higher-than-usual seasonal rise for tomatoes (up 98.0%).
The main individual downward contribution was lower prices for telecommunication services (down 2.5%). This reflected increased data caps for broadband plans and better-value cellphone services. Fresh milk (down 4.6%) and apple (down 19%) prices also fell.
“Electricity prices rose 4.5% in the June quarter. Prices had fallen a total of 0.7% over the previous three quarters, due to customers switching suppliers and bigger prompt-payment discounts. Electricity prices are now 3.7% higher than their previous peak in the June 2011 quarter,” Stats NZ prices manager Chris Pike said.
Cost of new Canterbury house builds up
Of the broader CPI groups, the household and household utilities group rose 1.0% during the June 2012 quarter, following rises of 0.7% in the March quarter and 0.3% in the December 2011 quarter.
As well as the 4.5% jump in electricity prices, higher rentals for housing (up 0.5%) also made a major contribution to the group’s rise, Stats NZ said.
“This was influenced by rises in Auckland and some areas of the South Island outside Canterbury,” Stats NZ said.
“Prices for the purchase of new housing [new residential builds] (up 0.9%) also rose. Rises were highest in the Canterbury region and in the rest of the South Island.”
Annual movement held up by ciggie taxes
The 1.0% annual rise in the CPI followed increases of 1.6% in the year to the March 2012 quarter and 1.8% in the year to the December 2011 quarter.
Stats NZ said the main upward group contributions came from:
- Housing and household utilities (up 2.7%)
- Alcoholic beverages and tobacco (up 6.2%)
- Miscellaneous goods and services (up 3.4%)
The communication group (down 9.5%) and the recreation and culture group (down 3.2%) made the main downward group contributions, Stats NZ said.
Inside those groups the main individual upward contributions came from:
- Cigarettes and tobacco (up 13%, reflecting higher excise duty)
- Rentals for housing (up 2.3%)
- Electricity (up 3.7%)
- Purchase of new housing (up 2.8%)
- Second-hand cars (up 5.3%)
- Local authority rates and payments (up 4.6%)
- Beer (up 4.9%)
Without the rise in cigarette prices, the CPI would have risen 0.6% annually, Stats NZ said.
The main individual downward contributions came from lower prices for telecommunication services (down 9.1%), audio-visual equipment (down 19%), international air fares (down 5.3%), and vegetables (down 5.1%), Stats NZ said.
Tradables vs non-tradables
In the June 2012 quarter, the tradable component of the CPI rose 0.1% and the non-tradable component rose 0.5%, Stats NZ said.
The tradable component measures the price levels of goods and services that are imported or in competition with foreign goods, either in domestic or foreign markets. Movements in the tradeables component demonstrate how international price movements and exchange rates are affecting consumer prices. The non-tradable series contains goods and services that do not face foreign competition. It shows how domestic demand and supply conditions are affecting consumer prices.
"The tradable component was influenced by seasonally higher prices for vegetables. International air fares, package holidays, and petrol prices also rose. The main individual downward contribution to the tradable component came from lower dairy product prices. Fruit and audio-visual equipment prices also fell," Stats NZ said.
"The rise in the non-tradable component was mainly influenced by increased electricity prices. Beer, rentals for housing, and purchase of housing prices also rose. The main individual downward contribution to the non-tradable component came from lower prices for telecommunication services," it said.
"For the year to the June 2012 quarter, the tradable component decreased 1.1 percent, reflecting price falls for audio-visual equipment and vegetables. This is the largest annual decrease in tradables since a 2.3 percent fall in the year to the March 2004 quarter. Prices for the non-tradables component increased 2.4 percent, reflecting price rises for cigarettes and tobacco, rentals for housing, and electricity."
The CPI measures the rate of price change of goods and services purchased by New Zealand households. Statistics New Zealand visits 3,000 shops across New Zealand to collect prices for the CPI and check product sizes and features.
Reaction
Westpac:
June quarter CPI rose 0.3% in the June quarter, taking annual inflation to a decade-low of 1.0%. This was weaker than markets or the Reserve Bank expected. Given that the main surprise was a lack of housing-related inflation, this data is an argument for more delay before the RBNZ considers increasing the OCR.
As expected, the high exchange rate and stagnant petrol prices contributed to limited tradables inflation. Tradables prices have fallen 1.1% over the past year.
The key factor we were watching ahead of this CPI release was housing-related inflation. Last quarter, construction-related and housing-related price rises were quite strong, raising warning bells about the possible inflationary impact of the Canterbury rebuild and housing market recovery. This quarter's data assuaged those concerns. Rents rose only 0.5%, after a 0.9% increase last quarter. Property maintenance prices, which includes handymen's charges, fell 0.4%, partially unwinding the worrying 1.2% spike from last quarter. That's not to say housing-related inflation is completely absent - the "home ownership" category, which includes the cost of building new houses, rose another 0.9% to be up almost 3% on a year ago. It's just that housing-related increases were less than expected.
For now, the data backs the RBNZ's view that the Canterbury rebuild and housing market resurgence will not generate inflation. Given the low level of headline inflation, we will review our OCR forecast with an eye to a later start date for hikes. Our current forecast is for a series of OCR hikes beginning in March 2013. That said, we doubt that the RBNZ is seriously considering reducing the OCR. Although inflation is currently low, the lack of exchange rate appreciation this year and accelerating economic growth are strong indications that inflation will rise to some extent over the next couple of years. It is still too early to definitively judge how much inflation the Canterbury rebuild will eventually provoke.
Market reaction
The two-year swap rate fell 4 basis points and the NZD fell about 15 pips.
ASB
The 0.3% increase in the CPI over the June quarter was below our and market expectations. From our perspective, the weaker than expected inflation result was driven by weak tradable inflation, as subdued household demand continued to put downward pressure on the price of imported household goods. While strength in the NZ dollar had given retailers scope to discount, the widespread price declines across appliances, cars and electronics suggest the extent of discounting was greater than this over Q2. Weak household demand and the high NZ dollar have seen tradable inflation fall 1.1% for the year to June.
Non-tradable inflation increased a modest 0.5% over Q2, in line with our expectations. As expected, the increase was largely driven by a 1.0% increase in the housing and household utilities group. This reflected higher electricity prices over the quarter. Added to that are signs of a pick-up in housing-related costs, with rents rising 0.5% and construction costs rising 0.9%. StatsNZ noted the increase in rents was concentrated inAuckland and the South Island excluding Canterbury, while the increase in construction costs was concentrated in the South Island. Recent housing market data had pointed to housing supply constraints inAuckland and Canterbury, and this has flowed through to relatively larger increases in housing-related costs inAuckland and the South Island.
Recent business surveys point to emerging capacity pressures in the building sector in Canterbury as the rebuilding got underway, and we expect a further boost to construction cost inflation as rebuilding ramps up later this year.
Communications prices dropped a larger than expected 2.5%, reflecting more generous data caps for broadband plans and better-value cellphone services. There has been substantial declines in communication prices over the past year.
The subdued inflation environment is also reflected in core measures of inflation, with the annual increase in the trimmed mean and weighted median all below the mid-point of the RBNZ’s target band of 2%.
Implications
The smaller than expected increase in consumer prices over the June quarter reflects the subdued nature of household demand, which is continuing to put downward pressure on the price of imported household items such as electronics and appliances. While there are signs of a household recovery taking place, this is very gradual and retailers’ margins remain squeezed. This is in line with recent business surveys pointing to a decline in retailers’ pricing intentions.
The pick-up in housing related costs is a key development to watch over the coming year. There are signs of housing supply constraints in Auckland and Canterbury, and this looks to be flowing through to rent increases. Meanwhile, rebuilding activity has seen capacity in the building sector in Canterbury diminish, which in turn is putting upward pressure on construction costs. We expect that as rebuilding activity gathers momentum later this year this will underpin an acceleration in construction cost inflation. The degree to which this flows through to wider inflation pressures in the rest of NZ will be a key determinant of how long inflation pressures in the NZ economy remain contained.
For now though, the RBNZ will be very comfortable with the current inflation environment. Pricing intentions and inflation expectations are continuing to ease, and annual inflation is now at the bottom of the RBNZ’s target band. We expect annual inflation will track around the mid-point of the RBNZ’s target band over the coming year. With uncertainty over the Eurozone debt crisis continuing to dominate the RBNZ’s outlook, the contained inflation outlook adds to the case for little urgency for the RBNZ to raise the OCR. We expect the RBNZ will keep the OCR on hold until at least March 2013.
JP Morgan
New Zealand today posted a fourth consecutive CPI report showing inflation annualizing below 2%. Consumer prices rose a meager 0.3%q/q in 2Q12, and 1.0%oya, which represents the smallest annual rise since 1999, and sees the RBNZ flirting with a downside breach of the target band. As the downward impulse from the elevated currency fades, the relatively stronger trend in non-tradables prices will lift inflation back to more normal levels, but the breadth of the softness in today’s report bears witness to the extent of accumulated slack in the economy. Outside of persistent stickiness in household utilities and rents, the price data therefore is giving the RBNZ the latitude to tread softly in its normalization path, even with the turn in the housing market and construction activity providing some support to demand. We forecast the RBNZ to begin raising rates with a 25bp hike in March 2013, but given the trajectory of the inflation data, the risks now are skewed to a later move.
The majority of categories in the CPI basket saw a deceleration in 2Q12. Food prices edged up a modest 0.1%q/q, with a turn in fruit and vegetables prices (+4.3%q/q) offsetting softness in meat and other groceries. We expect a similar (though larger) bounce-back in fresh produce in Australia’s 2Q CPI print next week. Alcohol and tobacco suffered the expected slowdown (from 4.7%q/q to 0.7%q/q) following the prior lift from an excise rise. Household contents and services were flat, with a fall in the price of appliances, while clothing and footwear similarly was benign (0.2%q/q), and the recreation and culture group lost 0.3%q/q, due to lower prices for AV equipment, all of which reflects weaker import prices.
In contrast to global themes, petrol prices (+0.4%q/q) made a significant positive contribution to inflation in 2Q, with the fall in WTI landing too late in the quarter to offset 1Q’s gains. In an ominous sign for next quarter’s print though, Stats NZ noted today that if petrol prices were to average at their end-June levels through to September (and the evidence so far admittedly is to the upside of that), petrol would drag 0.4%-pts off inflation in 3Q. Further, the remarkable slide in the communication group continues, with such prices down 2.5%q/q, due to the continued phase-in of higher data caps for broadband plans, which is lowering the effective cost per unit of data. Prices in this group have now shed 28% over the last year.
Not surprisingly, given the very benign readings in the majority of basket groups, the exclusion measures of inflation looked just as toothless as the headline measure. Most of the ‘all groups less…’ indices came in at 0.3%q/q, and the range was 0.1% to 0.4%. The lower end of that range is generated by excluding housing and household utilities, which is the only group lending any upside bias to inflation in the near term, and explained 75% of the rise in consumer prices in 2Q. The housing group was up 1.0%q/q and 2.7%oya, with rents (0.5%q/q), home ownership costs (0.9%q/q) and energy prices (+3.9%q/q) all posting strong rises, reflecting capacity issues in the building and electricity generation sectors. Those impulses have continued the familiar theme where non-tradables inflation (0.5%q/q) runs a little hotter than prices overall. Given that there is no evidence of spillover from higher house prices or utilities costs into consumer spending behavior or wage claims though, we think the RBNZ will be content to take a broad-strokes perspective on price dynamics, and under that approach it is hard to come to any other conclusion than to say the Bank needs to keep rates low for quite a while yet.
Looking beyond New Zealand’s shores, today’s data has subtle implications as we look toward next week’s 2Q CPI print for Australia. There is a decent historical correlation between inflation in the two countries, which on face value lends some downside risks to next week’s Aussie number. However, much of that correlation holds only in a through-the-cycle sense, reflecting the fact that Australia is New Zealand’s largest trading partner, which means output gaps and currency dynamics in the former generally will be reflected in the latter as well. Only over the last couple of quarters has the correlation been useful in contemporaneous forecasting, due to the narrowly-focused swings in fresh produce prices that followed the recovery in Australian fruit and vegetable production, which were witnessed in the NZ CPI data before Australia’s.
For this reason, as much as we recognize familiar themes in the inflation data between countries – the broad disinflation in tradables groups due to currency strength in particular – the comeback in produce prices in NZ in 2Q is the only explicitly identifiable force that should be witnessed in Australia too. This suggests that the tradables impulse will be offset by the upside in food prices, and in our view leaves us with balanced risks on our 2Q CPI forecast (0.5-0.6%q/q) which we will release later in the week.
(Updates to clarify overnight market pricing before today's figures - that markets were picking a 13% chance of a 25 bps cut at the RBNZ's next meeting, rather than pricing in 13 bps worth of cuts.)
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