How quickly will inflation come down?

Tuesday, 30 August 2022

Higher inflation may be ‘down but not out’.

Inflation is on the way down after reaching the annual rate of 7.3% in the June quarter economists seem to agree, but what they are less sure about is how fast it will fall.

The rate of decline is not only of interest to people managing a budget or trying to work out what sort of pay rise to ask for.

It is also likely to determine whether fixed mortgage rates have reached their peak, as Kiwibank now believes, or could creep higher.

“It's not enough for inflation to turn, it has to drop fast and I think that's a risk that's underappreciated by markets,” says ANZ chief economist Sharon Zollner.

* Does unemployment really have to rise to bring down inflation?

* Fixed mortgage rates may have peaked, says Kiwibank

The consumer price index (CPI) records changes in the price of hundreds of goods and services. (First published January 20, 2022)

If the Reserve Bank’s forecasts are right, inflation will have fallen to 5.8% by Christmas and to 3.8% by the end of next year.

BNZ sees inflation falling significantly faster, to 5.2% by Christmas and 3.1% a year after that.

ANZ, on the other hand, forecasts inflation will ease off more slowly to 6.1% by the end of the year, but then crash to 2.5% by the end of next year.

There is broad agreement on why inflation should have peaked.

Central banks around the world have begun talking and acting tougher on inflation, raising interest rates even in the face of sapping confidence and growing fears of recessions.

At the same time, most commodity prices have stabilised or are already retreating after spiking in the wake of Russia’s war on Ukraine.

Droughts in Europe and China could give a flesh leg to food-price inflation, ASB chief economist Nick Tuffley says.

S&P’s global chief economist Paul Gruenwald said at a seminar on Tuesday that economies were clearly slowing, though he said indicators of sentiment looked “gloomier than the real data”.

“Some inflation indicators appear to be peaking. But that was also the case about a year ago, so we'll need to see more data,” he said.

Behind the varying predictions of how fast inflation may fall in New Zealand lie different assumptions about how just how tough a nut domestic inflation will prove to be.

BNZ research head Stephen Toplis believes the combination of falling global commodity prices and a softening housing market will “meaningfully” impact inflation in the current quarter.

He predicts “the initial drop will be marked”.

Reserve Bank governor Adrian Orr speaks with Stuff a day after raising the official cash rate in August. (Video first published August 18, 2022)

Fellow BNZ economist Craig Ebert believes the Reserve Bank is feeling confident it is “getting close to getting on top of things”.

But Zollner appears more pessimistic, warning there is a lot of uncertainty about how “sticky and persistent” inflation will be.

Her take is that the Reserve Bank is “nowhere close to getting around this inflation problem yet”.

Much may depend on what now unfolds in the labour market.

Economists are universally expecting unemployment to rise, with the Reserve Bank tipping the official unemployment rate will climb further from 3.2% in the June quarter to 4.5% by the end of next year.

While that might seem a fairly modest change, it is not so much unemployment itself that has the most potential to impact inflation, as a drop-off in hiring.

There is growing evidence – at least internationally – that the bigger driver of wage inflation is currently workers changing jobs for higher pay, rather than employers offering pay rises to their existing staff.

The United States’ Pew Research Centre reported late last month that the typical US worker who changed jobs in the year to the end of March saw their pay rise by 9.7% more than the rate of inflation, while the typical worker who stayed in their job saw their real wage decline by 1.7%.

Economists speaking at S&P’s seminar saw plenty of international wildcards that could have a knock-on effect on inflation here and whether the economy experiences a “hard or soft landing”.

Gruenwald says China has been “the number one driver of global growth over the last couple of decades”, contributing about a third of total global economic growth.

But he says he has never seen a year in which Chinese authorities missed their growth target by such a wide margin.

“Premier Li Keqiang was talking about 5½% growth earlier this year and it looks like China is going to come out with something closer to 3% and that has impacts not just for China, but for the rest of the world.”

ASB chief economist Nick Tuffley notes the significance of Russian president Vladimir Putin “holding his foot on the throat of Europe’s gas supplies”.

“It is certainly having an impact on European growth.”

And he says the impact of the war on Ukraine could be dwarfed by the potential impact of recent extreme weather around the world.

“You've got droughts in Europe, you've got phenomenal droughts in China. And over the next year, that could potentially have some profound impacts on what will happen to food prices, that may compound the impacts of the war,” he says.

Given those concerns, movements in inflation may not all be one-way traffic.