Inflation expected to reach the highest level in 31 years, so what will cost more in 2022?

Monday, 24 January 2022

Econ Talks - inflation spikes to 4.9 per cent in September quarter.

Inflation is expected to reach its highest level in 31 years in 2022.

The Treasury expects inflation figures released by Stats NZ on Thursday will show the consumer price index, a measure of inflation, is rising at an annual rate of 5.5 per cent.

“What’s become so concerning about the rise in inflation over recent quarters is that it’s become harder and harder to pinpoint individual items in the CPI that are the main drivers of inflation,” ANZ economist Finn Robinson said.

“That’s because inflation pressures have become so broad-based across the economy. Inflation is under every nook and cranny, eating away at the purchasing power of Kiwi households.”

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He said economists were expecting that annual inflation was 6 per cent in the year to December 2021, accelerating from 4.9 per cent in the September quarter.

That would be double the top of the Reserve Bank’s 1 to 3 per cent target range for inflation.

There are some key areas that are driving inflation pressures higher, Robinson said.

Anything imported (especially petrol)

Things we bring in from overseas, whether that be petrol, toys, or household appliances, are under price pressure.

‘We expect construction costs were up 14 per cent in the year to December 2021,’ Robinson says.

Accounting for just under 40 per cent of the consumption basket, these items have gone up sharply in price over the past year, with pandemic disruption driving shipping costs through the roof, as well as creating significant delays, Robinson said.

“With Omicron circulating around the world, causing further disruption, these imported goods and services are expected to have increased in price by 7.6 per cent in the year to December.”

For context, annual inflation in tradable items averaged just 0.2 per cent from 2010 to the end of 2019.

“A key imported good for New Zealand is petrol – which we expect rose 33 per cent over the past year.”

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Oil prices have surged globally over the Northern Hemisphere winter, which combined with further weakness in the New Zealand dollar against the USD has driven large price increases for Kiwis at the pump.

Construction costs

Construction costs were another big one, Robinson said.

Despite the shine coming out of the housing market, with ANZ estimating house prices fell a seasonally adjusted 0.5 per cent in December, building consents have set back-to-back records in recent months, providing a solid pipeline of work.

“Strong demand for building materials, combined with supply disruptions and a very tight labour market, have driven up the cost of building houses significantly in recent months.

“We expect construction costs were up 14 per cent in the year to December 2021.”

Food

The Stats NZ food price index shows that food prices likely fell 0.6 per cent in the December quarter – reflecting seasonal declines in things like fresh fruit and vegetables.

“But prices were still unseasonably strong,” Robinson said.

The annual increase in food prices accelerated to 4.5 per cent, while global price pressures and domestic labour shortages keep the pressure on.

Workers

A range of factors means that workers will be increasingly expensive and scarce over 2022.

Unemployment was already at a record low 3.4 per cent in Q3 2021, and the forecast was for it to fall to 3 per cent over 2022, Robinson said.

“That gives workers significant bargaining power to demand higher wages.

“And with the cost of living currently rising faster than wages, those wage increases can’t come fast enough for many households.”

The risk for the Reserve Bank, tasked with ensuring inflation is low and stable, is what economists call a wage-price spiral, Robinson said.

When wages rise without a commensurate increase in productivity, that pushes up costs for firms because they are paying more for the same amount of output.

This then means that consumer prices rise, so workers need larger wage increases to compensate.

Borrowing

“In order to get on top of any wage-price spiral, aggressive action is needed by the Reserve Bank.

“We think that the Reserve Bank will lift the official cash rate in steady 25bp increments to 3 per cent by April 2023,” Robinson said.

That will push up the cost of borrowing for households and businesses.

“It won’t be fun – especially given how much house prices have increased in the past two years, and with growth risks to the downside as the economy struggles against Covid disruptions.

“But central banks are independent precisely because they need to make these tough choices.”

A lot of discussion to date has centred on price increases being mainly for goods that are most acutely affected by supply chain disruptions and other shortages, he said.

“However, we are increasingly beginning to see businesses in industries completely unaffected by supply chain challenges are lifting their prices.

“Businesses are anticipating that cost increases are here to stay, so many are going to take the opportunity to lift prices to protect their margins.

“Many households will find that these price increases will begin to affect their consumption of services in particular where price increases have been more muted to date.”