Some good and bad news on the inflation war

Inflation went the RBNZ’s way last week, but the war on high and sticky inflation is far from won, Sharon Zollner, ANZ’s chief economist says. 

“There is plenty in the first quarter (Q1) CPI data for both the doves and the hawks to focus on, and while these data do tell a better relative story than the February monetary policy statement (MPS), it’s still a pretty bad picture in an absolute sense,” Zollner says.

Inflation is still running near a multi-decade high, and annual non-tradables inflation, alongside a few other measures of typically-sticky inflation, were still accelerating as at Q1, she says.

“While it is important for the RBNZ to appropriately account for the lags with which monetary policy typically works, we think it’s a bit of a stretch to think the data will give it good reason to blink before taking the OCR to 5.5%.”

In particular, says Zollner, the weaker starting point for non-tradeables inflation versus the RBNZ’s February MPS forecast needs to be weighed up against the potential for more fiscal stimulus come Budget 2023, potential green shoots emerging in the housing market, and the fact the RBNZ has signalled it will likely revise up its estimates of the inflation impacts of Cyclone Gabrielle in the May MPS.

“Scratching under the surface of the data, the fact that 81% of the CPI basket was running above 2% doesn’t bode well for either the persistence of inflation or inflation expectations.

“Meanwhile, the rotation from goods to services inflation suggests sticky inflation risks have not yet turned a corner, even though headline inflation has.”

Westpac’s economists say although the CPI was weaker than it and other analysts expected in the early part of this year, crucially, it has fallen well short of the RBNZ’s forecasts for a second quarter.

This still leaves a picture of strong price pressures, including strong domestic inflation, says chief economist Kelly Eckhold.

“However, inflation has now peaked and signs that rate hikes are weighing on demand are mounting. Against this backdrop, we expect only one more 25bp rate hike from the RBNZ, but interest rates will need to remain high for some time yet.

However, the chances of the central bank needing to take the OCR above 5.50% have fallen.

He says the RBNZ is now firmly in the sweet spot where interest rate rises should be having an impact on inflation.

While widespread mortgage rate fixing in the New Zealand market has delayed the impact of interest rate increases, a large number of mortgages have now rolled on to higher interest rates.

Accounting for the extent of mortgage rate fixing, the average ‘effective’ interest rate on residential mortgages has already increased by around 100 bps since early 2022, Eckhold says.

Over the rest of this year about 50% of all mortgages will roll over to much higher interest rates. “That will see the average mortgage rate rising by a further 160 bps over the year ahead, which will further dampen demand, the labour market and wage growth, and ultimately domestic inflation.”

ASB chief economist Nick Tuffley says the inflation outlook is inherently uncertain, with the full inflation impacts of Cyclone Gabrielle yet to come.

He says despite encouraging signs, the more persistent and policy relevant domestic and core inflation measures remain well above the RBNZ’s 1-3% inflation target band.

“The RBNZ’s ‘least regrets’ analysis will highlight the risks of a more protracted period of high inflation and the much greater economic damage that this could cause.

“Inflation has been above the 1-3% target band for two years now, and the RBNZ will not want this inflation overshoot to continue for longer than is absolutely necessary.

Tuffley says on balance, the bank’s economists expect a further 25bp OCR increase in May to 5.5%, with the RBNZ needing to impose restrictive OCR settings for a concerted period to push inflation lower.

He says, however, last week’s CPI figures suggest that past OCR hikes are gaining traction and look to be towards the peak of the current hiking cycle.

“OCR cuts will only be contemplated when sub 3% CPI inflation is in prospect, but this is unlikely to be seriously considered until well into next year,” says Tuffley.