Inflation drop not expected to sway Reserve Bank

Thursday, 25 January 2024

A sharp drop in annual inflation may not be enough to persuade the Reserve Bank to dial down its tough talk on the future level of interest rates, economists believe.

Stats NZ reported on Wednesday that annual inflation had fallen to 4.7% in the December quarter, down from the 5.6% annual rate it recorded in the September quarter.

However, the big drop in inflation was mainly thanks to a decline in the price of imports such as petrol, which ANZ warned might not necessarily continue.

Economists expect still-stubborn domestic inflationary pressures, caused in part by high immigration and reflected in significant rent increases, will dissuade the Reserve Bank from acknowledging a likelihood of interest-rate cuts later this year.

ANZ expected the details in the inflation data would instead ensure the central bank maintained a “wary” tone when it releases its next monetary policy statement on February 28.

Infometrics principal economist Brad Olsen also did not believe the inflation drop would give the central bank cause to change its hawkish narrative on interest rates.

Kiwibank chief economist Jarrod Kerr said that although the inflation data was a step in the right direction, price pressures did not appear to be easing fast enough to force a pivot by the Reserve Bank towards rate cuts.

ASB chief economist Mark Smith described the details in the inflation figures as “lopsided” and not as benign as the Reserve Bank would have been hoping for.

“It did not provide the Reserve Bank with complete reassurance that its extensive monetary tightening to date is gaining traction,” he said.

The Reserve Bank on the one hand, and bank economists and financial markets on the other, have been locked in something of a stand-off since November.

The central bank has been forecasting the official cash rate won’t fall below 5.5% before around July next year and has even raised the possibility of one more rate rise to 5.75%.

But financial markets — both before and after Wednesday’s inflation update — have been largely dismissive of the chance of a hike, instead pricing-in interest cuts later this year.

ANZ was the latest bank to change its outlook for the official cash rate, when it last week pencilled-in a drop in the key interest rate to 5.25% in August.

Wednesday’s inflation data estimated that the prices of imports and other goods whose prices are largely determined internationally fell 0.2% overall in the December quarter, from three months earlier.

That lowered the annual rate of so-called “tradeable inflation” to 3%, from 4.7% in the September quarter.

But the price of goods and services whose prices are mainly determined by domestic price pressures rose 1.1% quarter-on-quarter, with the annual rate of “non-tradeable inflation” falling much less steeply to 5.9%, from 6.3% in the September quarter.

The quarterly increase in the price of non-tradeable goods and services was higher than the 0.9% increase that the Reserve Bank had been expecting.

BNZ research head Stephen Toplis said overall inflation was “plummeting”.

“The economy is, for all intents and purposes in recession, inflation is falling rapidly and the labour market is easing very quickly. It all says ease.”

But he also acknowledged the non-tradeable inflation figure meant the Reserve Bank might not see it that way, suggesting the gulf between the central bank’s interest-rate forecasts and market expectations might make it difficult for it to give ground.

“Despite the Reserve Bank’s best efforts to dissuade it, the market is currently pricing-in three rate cuts by the end of this year.

“While we think this is entirely appropriate, we’re not convinced the Reserve Bank would wish to condone this at this juncture. Were it to do so then there is a very real risk that the market would rally further into territory that would very much unnerve the bank.”

Stats NZ estimated that rents, which the Reserve Bank has been keeping a particularly close eye on, rose 1.1% over the quarter and 4.5% over the year.

Trade Me reported on Wednesday that the median weekly price of rental properties advertised through its website rose to a new record of $625 in December, up $45 over the year.

The Reserve Bank warned in November that strong population growth had contributed to an increase in rents.

However, preliminary estimates from Stats NZ suggest net immigration dropped sharply to 4637 in the month of November, from 10,539 the month prior, indicating the migration boom might be drawing to a relatively quick close.

Adding another wild card to the mix, ANZ said that while weak tradeable inflation was helpful and the price of food, airfares and fuel were “returning to a new normal”, risks such as tensions in the Red Sea meant that could change quite quickly.

Shipping costs had more than doubled since the turn of the year, after Stats NZ’s latest inflation data was compiled, it said.