More doubt over interest rate cuts after inflation surpises at 1.4%

Friday, 22 January 2021

Banks had forecast annual inflation would dip to between 1 and 1.2 per cent.

Annual inflation has come in significantly higher than expected, at 1.4 per cent in the December quarter, Stats NZ has reported.

The annual rate is unchanged from the September quarter, but economists had been expecting a drop.

The surprise may be bad news for the housing market as the figure appears to have largely killed off expectations that the Reserve Bank might cut the Official Cash Rate below its current level of 0.25 per cent this year.

In perhaps the boldest commentary on the surprise, BNZ research head Stephen Toplis said the inflation data, along with recent increases in world commodity prices, suggested annual inflation would “push above 2 per cent – and perhaps meaningfully so – before the end of 2021”.

Westpac economist Michael Gordon said the inflation figure was “a much stronger result than expected” and made an interest rate cut less likely.

As of Thursday, Westpac has no longer been forecasting a cut in the OCR.

* ANZ forecasts OCR will bottom-out at 0.1% this year

* Fears grow that inflation may be waking after bond yields jump

Kiwibank economist Jarrod Kerr also cancelled its expectation of a rate cut, saying it “now expected the OCR to be left unchanged, well into 2022”.

Accommodation prices are up on a year ago, confounding expectations about what would happen following the loss of international tourists.

“The rampant advances in the housing market have surely taken a negative cash rate off the table,” he said.

ANZ had forecast annual inflation would dip to 1.2 per cent, with a 0.3 per cent rise in the consumer price index in the quarter, while Westpac and BNZ had tipped the annual rate to fall to 1 per cent.

ASB and the Reserve Bank had been forecasting 1.1 per cent.

Stats NZ said higher prices for accommodation, new homes and used cars resulted in a 0.5 per cent quarter-on-quarter rise in the consumer price index (CPI).

“On a quarterly basis, domestic accommodation services were the top contributor to the CPI increase, up 20 per cent in the December quarter, despite the impact of the Covid-19 pandemic on international tourism.”

The figures indicate that the loss of international tourists hasn’t made holidaying in New Zealand cheaper for Kiwis.

Gordon noted prices for domestic accommodation were now higher than a year ago, pre-Covid, “despite the absence of overseas tourists”.

ANZ is still forecasting the official cash rate will drop, to 0.1 per cent, but warnings that rates may move higher sooner than previously expected are growing.

Westpac still expected inflation to “remain on the lower side” of the Reserve Bank’s target over this year, he said.

“For us, the surprise was largely on the tradables side, and in particular for big-ticket imported items.

“With overseas holidays out of the question, many people have diverted their spending towards items such as cars, furniture and electronics.

“At the same time, imports have been disrupted for various reasons, leading to shortages of some items, particularly ahead of the Christmas rush,” he said.

Westpac had made some allowance for this effect in its forecast, Gordon said.

“But it proved to be much larger than anticipated. It’s likely that some of these price increases will prove temporary, however, as the supply chain is eventually ironed out.”

ASB economist Mark Smith came to a similar conclusion.

“We expect annual headline inflation to ease early this year but to gradually firm thereafter, with more upside risk now accumulating to the inflation outlook,” he said.

“The diminished risk of deflation suggests that the OCR is unlikely to move lower from its current 0.25 per cent low.”

The Reserve Bank was likely to maintain “highly stimulatory settings” until it was confident that economic activity and the labour market had turned the corner, he said.

“Our view is that the OCR is unlikely to move up in 2021, but the resilient tone of New Zealand data is a reminder that the OCR won’t stay at record lows forever.”

ANZ is forecasting one more rate cut to 0.1 per cent this year, but said the inflation announcement “does pose some risk that the Reserve Bank does not need to cut the OCR further if momentum in the economy can be maintained”.

Infometrics economist Brad Olsen put the inflation surprise down to supply chain issues, capacity constraints “and a return to more usual levels of economic activity”.

“This higher inflation rate should all but close the door on any further easing in monetary policy in the first half of 2021,” he said.