By Bernard Hickey
Inflation was weaker than expected in the June quarter, piling yet more pressure on the Reserve Bank as it struggles to deal with both surprisingly low CPI inflation and double-digit house price inflation.
Statistics New Zealand reported the Consumer Price Index (CPI) rose 0.4% in the June quarter, which was weaker than the 0.5% consensus forecast by economists and the 0.6% forecast by the Reserve Bank in its June 9 Monetary Policy Statement (MPS).
The CPI was up 0.4% from the same quarter a year ago, which extends to seven consecutive quarters the period when annual inflation has been below the 1-3% band targeted by the Reserve Bank.
The result is expected to ramp up extra pressure on the Reserve Bank to cut the Official Cash Rate (OCR) again at its next decision on August 11. The New Zealand dollar fell more than half a cent to 70.7 USc immediately after the result and short term market interest rates fell by 3-4 basis points as market expectations of a rate cut rose from around 50% to closer to 70-80%.
The central bank is seen as squeezed between a rock of below-target CPI inflation and a hard place of double-digit house price inflation that it worries is increasing risks to financial stability. Further rate cuts could add fuel to the ‘halo effect’ spreading out from Auckland’s housing market, but leaving rates unchanged would make it harder for Reserve Bank Governor Graeme Wheeler to achieve his Policy Targets Agreement (PTA) target for CPI inflation of around 2%. CPI inflation has been below 2% for five years. The bank is scheduled to issue an unscheduled statement on its economic assessment on Thursday morning.
Tradables inflation rose 0.6% in the quarter, due largely to a 5.3% rise in petrol prices, but this was below the Reserve Bank's 0.8%.
Non-tradable inflation, which is what the Reserve Bank can influence most directly, rose 0.3%. This was about half the consensus forecast and influenced partly by a 9.9% fall in domestic airfares in the quarter and a 9.4% seasonal fall in car rental rates. The non-tradable rise of 0.3% was below the Reserve Bank's 0.4% forecast.
The cost of newly built houses, excluding land, and rentals were the biggest drivers of non-tradable inflation, particularly in Auckland. The cost of building a house in Auckland rose 2.9% in the quarter and was up 7.6% for the year. The cost of renting a house in Auckland rose 1.0% for the quarter and 3.5% for the year.
The contributions of new housing costs and house rentals combined to be 0.5 percentage points for the year, meaning that without those contributions there would have been no inflation.
"Prices were influenced by several factors, including strong demand and the increased cost of componentry and labour associated with building a new house," Statistics NZ said of the rise of the cost of new housing, adding that changes to health and safety regulation had also influenced prices.
Prices to buy new houses in Wellington rose 0.3% in the quarter and rose 1.4% in Christchurch. Rents rose 0.2% in and 0.4% in Canterbury in the quarter.
Economists said both overall and non-tradable inflation was lower than expected, with the surprises coming from a falls in domestic airfares and rental car rates. They said the result increased the chances of another OCR cut on August 11.
ANZ's Philip Borkin said he still thought cutting the OCR again posed risks given the backdrop of a strong domestic economy and growing capacity pressures.
"However, given low headline inflation, already soft inflation expectations and the strong NZD, it does look like the RBNZ will be dragged back to the easing table once again," Borkin said.
First NZ Capital Economist Chris Green said he now expected the Reserve Bank would cut the OCR by 25 basis points to 2.0% on August 11.
"In the absence of a near-term sharp downward move in the NZD, we would assess around a 65%-70% probability of such a cut," he said.
ASB's Nick Tuffley said the underlying picture was of weak inflation once the effects of higher house building costs and rentals were stripped out. He saw a cut on August 11, before another cut to 1.75% at a later date.
"With the NZD lifting strongly over June and July, tradable inflation will remain very weak for some time and further prolong the return of inflation back to the middle of the target. Meanwhile, beyond construction costs and Auckland rents, there was very little evidence of broad-based increase in domestically-sourced inflation pressures," Tuffley said.
Infometrics' Gareth Kiernan said the door was now open for another OCR cut, but that Thursday morning's assessment would be important, particularly on the currency.
"Having hit a 14-month high on a TWI basis last week, the exchange rate remains uncomfortably high for the Reserve Bank, and the persistent lack of inflation suggests another cut to the OCR is likely next month," Kiernan said.
"The housing market will still be a concern for the Bank, but macro-prudential tools appear to be a more appropriate means than interest rates for addressing the housing market’s current problems. Strong building cost inflation is an unavoidable byproduct of the supply response that is necessary to try and address Auckland’s housing shortage."
We yet again find ourselves in the somewhat hypocritical position of calling for the RBNZ to cut rates, from a consistency perspective, while we think that doing so is not optimal for the long term stability of the economy.
If the RBNZ does not push ahead with a further rate cut, the NZD will reverse its recent depreciation in the blink of an eye. Indeed, we think the RBNZ will not only have to cut rates in August but leave the door wide open to one more cut thereafter if it wants to (a) gain some traction over the currency and (b) to maintain its own credibility.
BNZ's Stephen Toplis said the Reserve Bank now needed to follow through on Thursday and correct the market's mis-interpretation of Deputy Governor Grant Spencer's speech on July 7 as indicating the bank cared more about financial stability than inflation.
"We yet again find ourselves in the somewhat hypocritical position of calling for the RBNZ to cut rates, from a consistency perspective, while we think that doing so is not optimal for the long term stability of the economy," Toplis said.
"If the RBNZ does not push ahead with a further rate cut, the NZD will reverse its recent depreciation in the blink of an eye. Indeed, we think the RBNZ will not only have to cut rates in August but leave the door wide open to one more cut thereafter if it wants to (a) gain some traction over the currency and (b) to maintain its own credibility," he said.
(Updated with reaction, details)