Roger J Kerr says the RBNZ will find it harder and harder to defend the 2.5% OCR as inflation bites. Your view?

 By Roger J Kerr

There appears to be far too much complacency around the place about current and future inflationary pressures in the NZ economy.

Consider the following price increases occurring in the economy right now and see if you agree with the mainstream economist view that inflation is benign and presents no problems to the RBNZ:

- Electricity prices to households are on the rise again, the letter received at my house from Contact Energy was a 5% increase from 1 April. Mercury (Mighty River Power) has also announced price increases. All very nice if you can get away with it!

- Local Government rates are increasing around the country again this year from anywhere between 2% and 10%. All very nice if you can get away with it.

- Insurance premiums are up big-time as New Zealand is fundamentally risk re-rated in international re-insurance markets following the Christchurch earthquakes. Your Earthquake Commission levy also increases as they must start to rebuild their reserves.

- Beer prices are also increasing, up 3% for bottled beer from 1 March as the brewers pass on cost increases in raw materials, production and distribution. All very nice if you can get away with it.

- Petrol and diesel pump prices will be zooming up over coming weeks as the jump in international crude prices (due to Iran tensions) to USD123/barrel (Cash Dubai) is passed through by the oil companies. The NZD/USD exchange rate has not appreciated any further to match the crude oil increases.

- Construction costs to build a new house continue to increase with timber, steel, carpet and glass not exactly stable. Add on builder’s wage rates being pushed up by the skills shortages caused by the Christchurch rebuild.

The CPI Index fell 0.3% in the December quarter due to price decreases in food, communications/internet charges and household appliances/furniture. These price reductions appear to be once-off in nature and non-recurring to me and partly due to the strong NZD value in mid 2011.

The Kiwi dollar plunged from 0.8700 to 0.7500 over the second half of 2011 and therefore the currency impact pulling prices down will reverse in the first half of 2012 (importers generally hedge the currency three to six months forward, hence the lag effect).

My view is that the economy is currently expanding at an annual GDP growth rate of 3.00% (September quarter 2011 GDP increased at +0.8% and everyone is now revising up their December quarter to +0.6%) with the stronger momentum from late 2011 continuing into 2012. House prices are on the rise in Auckland due to the demand/supply imbalance caused by three year of undersupply. Even without these demand-side impacts, the supply-side drivers of inflation (listed above) are already on the increase.

Despite the higher NZ dollar value and despite the increased bank lending margins automatically tightening overall monetary conditions, the RBNZ will find it harder and harder to defend a 2.5% OCR rate as this year progresses.

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* Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com