Domestic increases add pressure on Reserve Bank as inflation hits a 31-year high

The biggest contributor to inflation in 2021 was housing and household utilities group, boosted by ballooning construction costs. Photo / 123RF

Inflation hit a 31-year high at the end of 2021, with a strong rise in domestic costs expected to create headaches for the Reserve Bank.

Statistics New Zealand said the consumer price index (CPI), the official measure of household inflation, rose by 5.9 per cent in 2021, the highest since 1990, shortly after the Reserve Bank was given new powers to use interest rates to keep prices stable.

While the figures were largely in line with expectations - several economists had predicted inflation hit at least 6 per cent last year - the breakdown of the theoretical basket of goods used to calculate the CPI suggested the current wave of increases is more of a domestic issue than some had expected.

Shortly after the figures were announced, Prime Minister Jacinda Ardern told reporters that the rise, predicted by commentators, was largely the result of global inflation pressures.

"New Zealand is alongside every other country that is experiencing this problem of ... high crude oil prices," she said.

While tradeable inflation - generally reflecting costs imported from overseas - rose to 6.9 per cent, this was actually below expectations. Non-tradeable inflation, made up of the components of inflation that are mostly domestic, was 5.3 per cent, well above expectations and at the highest level recorded since Statistics NZ began providing a breakdown of local and imported elements.

Economists warned that the increases were broad-based. Westpac's senior economist Satish Ranchhod said New Zealand's economy faced a "potent cocktail of supply chain pressures and firm domestic demand".

The large rise in fuel prices - which typically affect all consumers and products through higher transport costs - coupled with strong domestic inflation, increased the risk that inflation may become persistent, as workers demand pay increases for lost spending power and businesses seek to recover shrinking margins.

"The growing strength in domestic inflation is most worrying," economists at Kiwibank wrote, predicting that the latest wave of inflation may not have peaked.

"Cost pressures will persist and may even be exacerbated by Omicron. The inflation rate is expected to remain elevated."

The biggest contributor to inflation in 2021 was the housing and household utilities group, boosted by ballooning construction costs.

The cost of building a new dwelling rose by 4.6 per cent in the final three months of the year, bringing the annual increase in building a new house to 15.7 per cent for the year.
Infometrics economist Brad Olsen said the figures pointed to severe capacity constraints in the sector.

"It's possible that these ever-increasing construction costs and difficulty finding materials and labour might see more projects delayed in 2022 until there is more capacity in the sector."

As well as eating into spending power, high inflation is likely to lead to pain for homeowners with mortgages, with the Reserve Bank supposed to keep inflation within a band of 1-3 per cent, using the blunt tool of the official cash rate to achieve it.

ANZ, which recently warned that the cash rate might have to be hiked to 3 per cent by the middle of 2023 to bring inflation under control, warned there was a risk of "feedback loop" between high inflation and the tight labour market.

While Covid was hitting productivity, meaning employers were getting less output per worker, the same workers had the opportunity to jump ship if employers did not meet their demands for pay increase.

"There's more work to do in order to bring the surging domestic inflation impulse under control and that will weigh on an economy that's already struggling to grow in the face of ongoing Covid disruption."