Elevated inflation risks not hard to see

Roger J Kerr says surging capacity utilisation portends an inflation burst. Get ready for OCR rate hikes

2nd Dec 13, 6:20pm by Roger J Kerr

The interest rate markets should be well primed to expect an upbeat assessment of New Zealand’s economic performance and prospects in next week’s Monetary Policy Statement from the RBNZ.

Every piece of local economic data that has printed in recent weeks has confirmed the positive reading for our economy that I have opined on for many months.

Businesses across the board are very optimistic about growth, investment, profits and hiring more staff.

The sweet spot for the NZ economy continues and the only negative or headwind the RBNZ might be able to find for 2014 will be a slower neighbouring Australian economy and higher interest rates.

However, in a capital and labour resource constrained small economy, rapid expansion does lead to upside risks for inflation.

The RBNZ will choose their words carefully on this issue; however they cannot ignore the knock on inflationary consequences of higher capacity utilisation, particularly in the construction sector.

The accompanying chart demonstrates the close correlation between capacity utilisation and non-tradable inflation in New Zealand.

The chart excludes the GST increase pushing up inflation artificially in 2010.

The inference is clear and the RBNZ ignore this lead-indicator for inflation at their peril.

Therefore, the timing and extent of OCR increases in 2014 is all about where the exchange rate is and what tradable inflation is doing to offset the rising non-tradable inflation.

A lower NZD/USD rate below 0.8000 means the RBNZ must hike earlier and by more.

A NZD/USD rate well above 0.8000 means that lower tradable inflation will counter the rising non-tradable inflation.

Dr Wheeler’s decision-making will depend entirely on how much the USD strengthens on global FX markets (and thus against the Kiwi dollar) when the Federal Reserve starts to remove the candy.

-----------------------------------------------------------

To subscribe to our daily Currency Rate Sheet email, enter your email address here.

No chart with that title exists.

Roger J Kerr is a partner at PwC. 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

We welcome your comments below. If you are not already registered, please register to comment

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.

31 Comments

by MortgageBelt | 2nd Dec 13, 8:51pm 1385970660

What about consumer caution and lack of retail spending?

what about low wage growth?

what about near zero rates in usa, uk, eurozone?

Where is Australia heading with interest rates? Down.

How many years have we heard the tomtoms of rate hikes? [number between 3 & 4]

What about deflationary forces?

by Zombie ponzi | 2nd Dec 13, 9:36pm 1385973393

Are you saying you don't think inflation will pick up, or that the RBNZ should ignore it if it does?

If it does pick up as forecast then the reserve bank can either 'look through' inflation or hike rates.

I don't see the RBNZ 'looking through' so perhaps there are some more creative ways to keep the exchange rate down? Record terms of trade and an overpriced currency sounds like where Australia was about a year ago (and still is to a certain extent).

by MortgageBelt | 2nd Dec 13, 9:56pm 1385974560

Maybe Cost-Push inflation may rise a little next year. Higher interest rates will not contain this.

Inflation is currently at 1.4%. The RBNZ has a target range of 1 - 3% - so currently inflation is at the lower end of that band.

Inflation in NZ has been dead in the water since 1990 - the RBNZ has completely nullified and throttled any small sign of consumer / small business / local economic activity / demand-pull inflation since 1990. Now that all small businesses, small orchards/farms, small retailers, SME manufacturers have been absolutely hammered into the ground by an extremely high interest rate policy setting, we are ripe for all the large corporates & investment vehicles to run everything.

There are no signs of any Demand-Pull inflation or exuberance in the NZ economy - other than the B2B flows to Fonterra, &dragged out Chch rebuild etc - who only disperse their earnings via wages & peripheral contractors etc.

House price inflation is now primarily driven from foreign buyers non-resident and recent immigrants. So higher interest rates are not going to suppress this.

Wage growth is completely subdued - so is there more $$$ chasing more products & services? The money growth is from the home loan injection system & foreign investment - is that going to be contained?

Any interest rate rises over the next 3 years or so will have an exaggerated effect on the NZ economy - unlike the pre-2008 era.

by steven | 2nd Dec 13, 10:03pm 1385975008

Well put....very well put.

"an exaggerated effect" -\yes a negative one, that I think is the biggest danger.

regards

by steven | 2nd Dec 13, 9:57pm 1385974620

Yes no significant inflation to speak of.

Ignore, the RB has to watch it doesnt tip us into a recession.

The forecasters miss peak oil, huge debt, high un-employment so inflation is going no where, except -ve

regards

by Zombie ponzi | 2nd Dec 13, 10:14pm 1385975642

House prices need to come down and agreed it needs to be graudal. LVR restrictions and foreign buyer restrictions together might be too much. This is where some team work between the government and RBNZ would be helpful. A coordinated approach to policy beyond housing accord rhetoric. The great thing for National so far is that they have done absolutely nothing and this suits their voter base to a tee. A collapse in house prices following reform would be as disasterous politically as prices continuing to rise.

The RBNZ is doing all the heavy lifting on its own.

by steven | 2nd Dec 13, 10:21pm 1385976114

Agree.

regards

by steven | 2nd Dec 13, 10:14pm 1385975688

Roger, when you say "GST increase pushing up inflation artificially in 2010."

etc then sit back and wonder why couldnt be that all you see artificial, or in other words you cannot deal with it. Its push inflation so monetary policy is as dead as a dodo.

WIth all the printing, QE, low OCR's we are still desperately close to deflation and carry a high un-employment.....I just cant see inflation in < 3 years unless its -ve.

regards

by steven | 2nd Dec 13, 10:40pm 1385977250

"labour resource constrained" at 6%?

regards

by David George | 3rd Dec 13, 7:57am 1386010669

Agree Steven, where do they get these numbers and just where is the high capacity utilisation?

Labour - 6 or 7% unemployment - that's a 100,000 spare workers even allowing for the completly useless

Retail - massive over capacity from what I see and getting carved into on an ongoing basis by online sales.

Manufacturing - empty factories, idle plant and thousands of layed off workers

Hotel and resturant - low occupancy rates - you can't give away pubs in the non tourist areas.

Building - consents still well below historic highs despite Ch Ch effect.

Finance - already bloated beyond all reasonable needs.

The median income is stiil sitting below $30,000

Doesn't add up to a prescription for non tradeable inflation to me.

by steven | 3rd Dec 13, 10:04am 1386018274

He's also quoting in the graph non-tradeable inflation. So the non-tradeables in effect act like a tax or an OCR hike and take the money out of ppls wallets, that means the tradeables, ie jobs have to cope somehow.

So when he shows non-tradeables jumping, and no more money why isnt he asking whos getting a smaller share of teh pie, and the impact.

So indeed,

"The inference is clear and the RBNZ ignore this lead-indicator for inflation at their peril."

but not the way Roger thinks, I think...

Time will tell...

regards

by steven | 2nd Dec 13, 10:45pm 1385977500

"remove the candy."

and even a hint caused a near panic.

and the new Fed well be just as dovish.

regards

by MikeM | 3rd Dec 13, 7:44am 1386009888

I'm wondering if the author of this regular post has a huge short position on the debt markets. He's forever forecasting upward interest rates.

by steven | 3rd Dec 13, 8:38am 1386013134

Always an upside risk whch will take time to appear, never the downside which could be large and fast, despite comments on that. Interesting perspective, me Im expected to tell the client the whole picture and leave nothing substantial out.

regards

by Stephen Hulme | 3rd Dec 13, 9:11am 1386015091

Yes, a disclaimer of any biased professional interest should be demanded by the editor.

by steven | 3rd Dec 13, 9:25am 1386015959

Sorry but that made me laugh as it so much looks like an oxymoron. I mean a biased "professional"?

oh well.

regards

by Craig | 3rd Dec 13, 2:34pm 1386034476

Just the standard economist approach. They are so lacking in new ideas that they just bring outthe old 'it worked this way before' looking glass.

I am amazed how many orthordox economists use the same old broken models and ignore what happenned in the recent years.

by Grant A | 3rd Dec 13, 9:30pm 1386059431

Always good to debate views, but pays to be mindful that even if a bunch of like minded people can talk themselves into an alternate view to the markets, it doesn't make them right. Over the long term, whilst they don't get it right all the time, the markets get it right far more often than those with only a view of their immediate limited world and what they read about the rest of it. Hedging your view a little isn't a bad thing especially when it's so contrary to the markets (and coincidently most economists in this instance) which currently says April OCR hikes.

by ACB | 4th Dec 13, 11:34am 1386110098

Arguably the best indication of what the market is expecting in terms of inflation over a given period is to look at the break even inflation rate implied by the difference between the nominal bond yield and its inflation indexed equivalent (e.g. NZ has a 2025 inflation indexed bond on issue). I am suprised that fixed income experts in NZ commonly fail to mention this.

by Grant A | 4th Dec 13, 1:02pm 1386115367

Very true ACB, and at 2.2% currently, it suggests that the market expects the RBNZ to do whatever it needs to do to maintain the inflation at rate around their target level. What it doesn't tell you is how high the market expects to take rate to do that, and your best guess on that is the OIS swaps curve.

by ACB | 5th Dec 13, 10:39am 1386193188

True, of course the market could be wrong in its views of benign inflation and/or RBNZ fighting it successfully. If inflationary pressures are such globally that the RBNZ is unable to supress inflation without killing off the economy, then it would have been a great move to get inflation protection at 2.2%. We only need to look at the Bank of England as an example of where inflation fighting has become a secondary concern compared to growth and employment to understand that the RBNZ Act can be reinterpreted or adjusted. A change of government will do that quite quickly. Recall original target was 0-2% inflation, now it's 1-3%, so how about 2-4%? We're not necessarily talking rampant inflation but over 10 years, any relatively small adjustment in inflation targets will steal a considerable amount of your real wealth.

by MikeM | 5th Dec 13, 2:02pm 1386205353

April increase is looking more likely now with the Fed likely to taper before then, given the gradually improving US data. If anything will weaken the NZD, some tapering will. Just enough to squeeze in an OCR rise me thinks.

by Grant A | 5th Dec 13, 6:03pm 1386219801

Suspect you're right Mike. If its a March US QE tapering then the USD will go immediately higher, Kiwi lower, and RBNZ therefore much more comfortable to hike in say April.

It will also mean US long rates higher and NZ long rates higher with them which in turn will pressure the floater seven more and risk them into a very uncertain future if their no inflation/global blow up doesnt happen within the next couple of years. Who knows but the risks are increasing, risks that no one can quantify, risks that should be managed.

by cowboy | 5th Dec 13, 8:09pm 1386227362

Dunno, the USD is a bit of an odd beast because it's seen as a "safe haven"

(personally I think of it less of a "safe" haven, than people with open Risk exposure closing out before things get dicey...making it -look- like money is going TO USD, in reality it's just the close end of the money coming out earlier. IMO)

The other thing is most of those who are in the know will be figuring things into bids weeks ahead of the news releases - some are even on "fast feed news/mailing lists" to let them "get ready" for sudden market shifts. ...translation they sold the cheatsheets on the downlow for a quick'n'dirty profit. So come release day it will so be the slow and the retail investors responding. Keep an eye open for trends developing a few weeks out, as the big boys get in position, and try to throw a few fakes out there to caught the greedy. IMO. :)

by steven | 5th Dec 13, 8:53pm 1386229996

US jobs hardly any sign, new Fed chairwoman even more dovish than helicopter Ben.Taper 3 or 4 months into office? really? That will be interesting, think not myself. 2015...maybe even out later. Then look at the swedish effect, their RB tighened and sent their economy into shock....had to drop it back. Sure we'll see a taper but very slow and I think even un-announced til afterwards "oh yes we drop from 80billion a month to 75 3 months ago....

OCR rise here as a trend? Well un-employment is 6% not showing much change, not much manufacturing growth either. Now Im sure when its due it will happen this year? 50/50 at best. "sqeeze in" as in one? whats the point of just one? see swedish effect btw.

http://krugman.blogs.nytimes.com/2013/11/23/bubblephobia-and-monetary-p…

regards

by MortgageBelt | 5th Dec 13, 6:22pm 1386220959

NZ$ and Aussie $ soon to reach parity g7

http://www.smh.com.au/business/markets/currencies/aussie-kiwi-dollars-h…

by cowboy | 5th Dec 13, 8:22pm 1386228171

no sign of slowing down?

by MortgageBelt | 5th Dec 13, 9:02pm 1386230564

Aussie sinking fast.

Kiwi - over-rated by market atm.

We could see parity by mid-late 2014

by MortgageBelt | 5th Dec 13, 10:56pm 1386237414

Perhaps Wheeler is not the one really calling the shots.

Maybe NZ has been given the job of "High Interest, Commodity exporting Economy" "Place to park $$$ for super high rates on the way though".

MAybe it's not about us.

If Rate hikes start in NZ next year, it will be very interesting to see the general reaction.

by MikeM | 6th Dec 13, 10:45am 1386279936

Zz, the Aussie economy has expanded down only one channel in the last five or six years, being mining. If you ask the manufacturers and even retailers over there how they've fared over the same time period you'll get a bleak response. Now that the mining capex party is over wages will have to converge with GDP. Looking strictly at the terms of trade between both countries I'd say NZ is on the better path, especially if (and that's a big if) China makes the economic transitions its promising.

by iconoclast | 6th Dec 13, 11:10am 1386281443

More rubbish zeds, where do you get your nonsense from

OCR in AU and NZ are the same

While carded mortgage rates today

WBC 5.12%

CBA 5.20%

ANZ 5.22%

NAB 5.24%

advertising specials 4.99% in NZ

Check out the mortgage rates in the US of 4%+ where the OCR is 0.25%