Mortgage rate cuts a way off yet

Inflation looks unlikely to be back within the Reserve Bank’s 1-3% target band before the latter part of next year.

The Consumers Price Index fell in the June quarter from 6.7% in the first quarter and while there have been some big swings in some specific prices, the bigger focus for the RBNZ is the longer-term trend in prices.

Although the activity front shows signs demand is cooling, including sluggish retail spending, the economic cycle may still have some legs (such as the turnaround in net migration and signals the housing market may be heating up again), says Satish Ranchhod, a Westpac senior economist.

“Putting this all together, we continue to see the risk that the RBNZ will need to raise the OCR again.”

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Food is still the biggest contributor to inflation followed by housing – both construction and rents.

Building a new house increased 7.8% in the June quarter after an 11.5% rise in the first quarter of the year. However, the influence of the two-year swap rate on mortgages has stayed relatively steady at .5.3%.

Core inflation strength

“While inflation is lower, it is not low by any stretch of the imagination,” Ranchhod says.

“Importantly, measures of core inflation are continuing to run at rates of around 6%, and some have actually picked up in the June quarter. That points to lingering strength in underlying price pressures.

“Similarly, domestic inflation (aka non-tradables inflation) remains elevated at 6.6%. 

“Those simmering underlying price pressures mean that inflation is unlikely to return within the RBNZ’s target band any time soon.”

He says notably, several core measures have pushed higher over the past few months, highlighting the continued strength in pricing pressures.

Looking across the broad product groups, domestic (aka non-tradable) prices were up 1.3% in the June quarter and have risen by 6.6% over the past year. “The RBNZ pays particular attention to non-tradables inflation given its close connection to the strength of domestic economic conditions,” Ranchhod says. 

The central bank had forecast non-tradable prices to rise 1% over the quarter, and 6.3% in the year to June. “Non-tradables inflation is lingering at high levels, and has only nudged back slightly in the 18 months since the RBNZ began raising the OCR.

Prices for imported goods (sometimes referred to as tradables) rose by 0.8% over the past three months and are up 5.3% over the past year. That’s a further step down from the rates we saw last year, Ranchhod says. “However, that’s mostly due to the fall in fuel prices. Other tradable prices are up 8.4% over the past 12 months.”

What does today’s result mean?

While the CPI was in line with the RBNZ’s forecast, Ranchhod suspects the underlying details of the inflation report were actually firmer than the central bank anticipated.

In particular, non-tradables inflation is yet to show material signs of cooling. Excluding building costs, non-tradables inflation picked up to 7.1% in the year to June (vs 6.5% in the year to March), with services prices up 6.1% over the past year.

In its recent policy updates, the RBNZ signalled that it expects to keep the OCR at the current level of 5.50% for some time yet. However, Ranchhod says with underlying price and wage pressures remaining firm, the RBNZ still has a rocky road ahead.