The era of low-to-negative "helpful" imported inflation may be coming to an end, Reserve Bank chief economist Paul Conway says.
Conway told a Commonwealth Bank Global Markets Conference in Sydney on Tuesday [by video link from Wellington] that the "biggest forecast error" the RBNZ had made around last week's reported September quarter inflation figures was in the imported, or 'tradeables' area. The RBNZ had forecast that annual tradable inflation would have fallen from 8.7% in June to 6.5%, but in fact it fell only to 8.1%. The overall inflation figure was 7.2%, barely down from the 7.3% reported in June.
"Tradeables inflation is usually our friend," Conway said.
"So, over recent history, recent decades, it has been low to negative across the globe and that’s for a few reasons. First, globalisation – a sort of slow moving positive supply shock has kept a lid on global prices."
Related to this had been the Chinese labour market "moving from farms in the west to factories in the east" and China being the workshop for the world. And there has been "favourable demographics across a bunch of countries", Conway said.
"But much of that is changing at the moment.
"In the first instance that’s because of the pandemic and associated supply shocks.
"But globalisation is also changing, demographics are changing and China isn’t the deflationary force that it once was.
"So, there’s talk in serious academic papers arguing that greater international inflationary pressure could be a theme going forward.
"Obviously, hopefully not as extreme as what we’ve been witnessing over the last year or so, but that era of helpful tradeables inflation may be coming to an end."
In terms of the the overall inflation figure, of 7.2%, Conway said the RBNZ had picked 6.4%, "so quite an overshoot there from what we were expecting".
The 7.3% inflation as of June followed now by 7.2% was an “unpleasant situation for all of us", Conway said.
In explaining why the figure was high, he said the NZ economy has “roared” through Covid. There was a very strong policy response, big government spending with ultra low interest rates. The health response was very good. Kiwis got good at using digital technologies as well.
Household balance sheets strengthened. NZers were saved during the pandemic.
"Even now there is still a good buffer there."
The labour market has remained “crazy strong”. Workers are difficult to find. Which has been a fundamental change for NZ businesses. The labour market has been a rock.
And migration. It fell off a cliff. Net migration still negative.
“This is another fundamental change in New Zealand’s economic model. Traditionally we have grown our economy, New Zealand businesses we grow our businesses by throwing workers at them, but that model is sort of looking less likely going forward.
“I think migration inflows are always going to be important and beneficial for the host country and for the migrant, but there are increasing signs that the days of very large inflows of low cost labour into the country may be behind us.”
On the inflation figure then, Conway said: "Obviously too high. But as you would no doubt expect from a central banker we expect to see inflationary pressures easing going forward. We are hopeful that it has peaked."
He said the "rapid tightening" in monetary policy, which has seen the RBNZ hike the Official Cash Rate from the emergency setting of 0.25% as of October 2021 to 3.5% now - and with more expected - "is starting to have an effect".
“There are early signs that the economy is starting to cool; That demand and supply in our economy are coming back closer into balance."
On the housing market, Conway said prices were down about 10% from peak - although by much more in some of the big centres. This was partly about higher interest rates but also other fundamentals such as slower population growth, looser zoning regulations against major cities.
"So, again, this is a big change for the New Zealand economy. Traditionally we sort of traded houses among ourselves at ever increasing prices thinking that we were creating prosperity – but that’s not what’s going on currently. We’ve seen a sort of reverse wealth effect, which should work to slow down consumption."
In tandem with this, Conway was seeing a slow down in construction activity, in what he described as a “boom and bust” industry in NZ.
"We’ve actually been building quite a few houses over the past couple or three years, which is great and part of the reason we are seeing this moderation in house prices, but there are lots of signs pointing to an upcoming bust – or at least a significant slowdown in construction activity."
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