By Paul Bloxham and Daniel Smith*
The medium-term inflation view is what really matters.
New Zealand’s economy remains in a plumb position.
Inflation is low, but for the right reasons.
Falling oil prices and lower petrol prices may be driving down the headline inflation rate, but they also mean lower business costs and a significant boost to household disposable incomes.
At the same time, most timely indicators of growth continue to suggest that economic activity is running at an above-trend pace.
With little to worry about, the RBNZ can afford to keep rates steady for some time.
Indeed, given the fall in petrol prices, we expect inflation to be below the central bank’s target band until late 2015.
But, in our view, just because inflation is low does not mean that the RBNZ will be contemplating rate cuts. Indeed, we still expect that the next rate move will be up.
Keep in mind that, for monetary policy, it is the medium-term inflation outlook that really matters.
And, assuming the drop in oil prices is a one-off shock, that medium-term outlook has not changed dramatically.
We still expect 2015 to be another good one for the New Zealand economy, with growth continuing to run above its trend pace.
Growth is expected to get additional support from lower petrol prices. As the year progresses, we expect spare capacity to diminish further, the unemployment rate to continue to fall, and wage growth to edge higher. We see domestic inflationary pressures rising over time.
For now, the RBNZ is expected to be quite happy to sit still and, given lower inflation, it is expected to push out its own published hiking profile, when the next official statement is published on 12 March.
As a result, the January announcement will likely reflect a more neutral outlook, rather than the December statement’s explicit tightening bias.
Inflation is low, but still set to rise later this year
Lower petrol prices have pushed headline inflation below the RBNZ’s target band and are likely to take the annual rate of inflation even lower in Q1 2015 (Charts 1 and 2).
Ordinarily, rapidly slowing inflation could make a central bank somewhat nervous.
But, in this case, the RBNZ will most likely view the major driver – lower fuel prices – as a positive story for at least a couple of reasons.
Lower petrol prices increase households’ disposable income and reduce costs for many businesses; the end result should be stronger growth.
Also, while falling inflation means that real (inflation-adjusted) interest rates are rising, in New Zealand’s case, tighter policy as a result of increasing real rates may not be unwelcome, given that growth remains above trend.
Looking beyond the temporary impact of the oil price fall, the RBNZ’s assessment of the medium-term inflation outlook is unlikely to have changed much. Headline inflation will most likely lift again later this year, once the effect of the drop in oil prices fades.
Although domestically-generated, or non-tradable, inflation has been well contained, at 2.4% y-o-y in Q4, we expect it to rise as growth is expected to continue to run at an above-trend pace.
Capacity pressures are likely to increase, leading to higher pricing pressures.
In particular, as the unemployment rate continues to fall and the labour market tightens further, wage growth is likely to gradually lift and so is non-tradable inflation (Chart 3).
Growth outlook remains strong
New Zealand’s growth outlook has not changed dramatically from when the RBNZ published its last set of forecasts in the December official statement.
In fact, the major development has been the fall in oil prices, which should be a boost to growth.
Activity indicators, although lower than in early 2014, remain at high levels overall (Chart 4).
GDP data for Q3 2014 came in slightly above the RBNZ’s forecast, and the broad-based nature of growth suggests that it is increasingly sustainable: both households and businesses appear to have the confidence to spend and invest.
We expect the RBNZ to maintain the view that growth will continue to run above potential over 2015, at view we share.
We expect growth for the year as a whole to be 3.0%, down a little from an expected 3.3% in 2014.
Paul Bloxham is the chief economist at HSBC Bank Australia and Daniel Smith is an economist. Both are based in Sydney.