Inside Economics: Why inflation is back and why the Reserve Bank can probably ignore it

Welcome to Inside Economics. Every week, I take a deeper dive into some of the more left-field economic news you may have missed. To sign up for my weekly newsletter, click here. If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.

Can RBNZ ignore inflation?

Q: Dear Liam,

In the context of [the latest] food price inflation figure, can you please explain to me and the masses, the existence and relevance of “inflation on the supply side” versus “demand inflation” (if there is such a distinction) and their influence on interest rates.

The reason I ask is that the discretionary spend in New Zealand is very subdued (who would be in retail at the moment?) and is likely to be so for another 12 months.

Everyone is struggling, yet the RBNZ uses “inflation” per se as a prerequisite to interest rate movement.

I and virtually everyone I know have children, are ostensibly doing well, ie good jobs, own houses (with mortgages but not over-leveraged), but all seem to be doing it tough, even though in the scheme of things they would be considered to be in a relatively sound position.

I’m not convinced it’s demand which is fuelling inflation as such, so why can’t the RBNZ release the brakes? Interested in your thoughts.

Kind regards,

Simon

A: Good question, Simon, thanks for that, although I have to say I didn’t really want to be back here explaining the nuances of inflation so soon after the last big spike.

Here we are, though, with inflation back in the headlines and tipped to exceed the upper limit of the Reserve Bank’s (RBNZ) 1-3% target band in this current quarter.

The short answer to your question is yes – there definitely is supply side (or cost-push) inflation and demand side (demand-pull) inflation.

It’s the demand side that the central banks can control by tightening or loosening the money supply with higher or lower interest rates.

When there’s too much money in the system – as was the case after all the Covid stimulus – demand in the economy starts to exceed the capacity of the economy to produce goods and provide services. This causes prices to rise and produces inflation.

The reason economists remain relatively relaxed about the longer-term inflation outlook is that despite the current spike in demand, we currently have the opposite conditions in the economy.

The recessionary trend means demand is sitting well below the capacity of the economy, so at its core, inflation is easing and some prices are actually falling.

Building costs fell in the June quarter and there was annual deflation for furniture, furnishings and floor coverings, household textiles and household appliances.

So you are right in your assumption that it is a supply-side problem causing inflation right now.

That is, it is very specific cost increases that are driving the current spike in inflation.

On the tradeable inflation side (ie the side where the prices are determined by international pricing), we’ve seen a big rise in commodity prices for proteins such as dairy and beef.

That (as regular readers will be sick of hearing from me) is a net win for New Zealand as an exporting nation.

Where would the economy be without those extra billions of export earnings rolling in? In a deep hole is the answer.

Unfortunately, though, while prices are the headline grabber, the current inflation situation has been exacerbated by some non-tradeable (ie domestically priced) costs that have continued to rise.

Economists describe them as “administered costs” and the culprits are specifically council rates, power prices and insurance premiums.

We might want to throw a round of increases for streaming services into the mix, as they rose 9% in the last quarter.

Interest rate outlook

So, to answer the second part of your question, people are doing it tough, and it’s not demand that is fuelling inflation (well, not domestic demand anyway, international demand for protein is a factor).

That limits the control the Reserve Bank has over it. So it should be able to look through the latest rise and start cutting rates again soon.

And expectations are that it will.

Acting Reserve Bank Governor Christian Hawkesby is expected to announce at least one more Official Cash Rate cut this year. Photo / Mark Mitchell

I guess the RBNZ felt it was important to pause this month just to be sure that the inflation wasn’t becoming more deeply embedded in the core of the economy.

But Monday’s CPI numbers weren’t as bad as some feared and revealed that demand-side inflation continues to fall.

Economists now see a 25-basis-point rate cut as a near certainty when the RBNZ delivers its next Monetary Policy Statement on August 20.

After that, it depends on who you talk to, but most economists expect at least one more cut (probably in November) to take the Official Cash Rate to 2.75%. Some – such as Kiwibank and ANZ – feel another one might be needed, taking it to 2.5%.

Meanwhile, most expect the supply-side inflation will play through by the fourth quarter as food commodity prices tail off.

And nobody is expecting the demand side to pick up much until next year.

Social media vs reality (or, what I did in my holidays)

I’ve been immersed in US politics this year, thanks to Donald Trump’s tariffs and the various economic implications for New Zealand.

So it was a relief to take a two-week break from all the American political madness over the recent school holidays.

Ironically, I spent those two weeks in America, where real life seemed to be carrying on with a much greater sense of normalcy than you might expect if you rely – as most Kiwis do – on headlines and social media posts.

I’m not saying there aren’t big, unprecedented things happening in American politics. There are and many of them are very worrying.

But what struck me was that the media takes I’ve been getting from the left and the right had created a distorted picture of what things are really like on the ground.

From the left, I had the impression that the US would feel considerably more authoritarian than it did.

Almost every New Zealander I told I was heading to the US asked me if I was scrubbing my social media of political content – some suggested taking a “burner” phone.

I didn’t, but felt acutely aware that most of my criticism of Trump and US foreign policy is there for anyone to read on the Herald website.

Some commentators talk about the rise of American fascism.

Taken at face value, I’d begun to think that taking my family to New York in 2025 might be akin to visiting Germany in 1936.

Meanwhile, from the right, I was given the impression that big liberal US cities – such as New York – had descended into third-world chaos.

There is a particular strain of social media content that seeks to show cities such as New York (and London and Paris) as overrun by immigrants and with infrastructure crumbling after years of ineffectual, woke, bureaucratic management.

Anyway, I’m happy to report that all of it was nonsense.

Media takes from the left and the right create a distorted picture of what things are really like on the ground in New York. Photo / Getty Images

Border control was friendly and uninterested in my politics or who I was.

New York was buzzing with hot summer energy. Our mid-Town location landed us in the thick of the annual Pride Parade – a typically colourful and fabulous event.

There were no visible signs of politics. The city was highly functional and felt exceedingly safe.

On the subway and in Harlem, Brooklyn, the Bronx and Queens, things were lively and people were loud, but nobody was aggressive.

The level of homelessness seemed surprisingly low – certainly on a per capita basis compared to what I’ve become used to in Auckland.

Public transport was cheap and easy to use.

The only big change I noticed from my last visit a decade ago was that the volume of traffic in Manhattan was much lower because of congestion charging.

That just made the place more pleasant, to be honest.

Apart from getting this off my chest, what does it all mean for economy watching?

Well, not too much perhaps.

But I do worry that anxiety about the state of the world is a contributing factor to the lack of business and consumer confidence in New Zealand.

We need to get over that.

It’s the nature of media – both social and legacy – to amplify conflict and disruption.

Unfortunately, as a nation tucked away in the far corner of the world, it is hard not to let our views be shaped by the grim content on our news feeds.

I’m still concerned about tariff fallout and global conflict, and AI-driven social revolutions. But I feel less acutely anxious about it all.

Perhaps I just needed the break.

China focus

With this comforting anecdotal evidence tucked away to inform my coverage of US economic issues, my attention now turns to China.

I’m heading up to China in September on a work trip with the New Zealand China Council.

Given how much I’ve written about the economic downturn in China, I’m hopeful (and fairly confident) that I get a timely reminder of the scale of its economy and how epic that is, regardless of consumer sentiment.

China’s GDP landed at an annual rate of 5.3% for the June quarter, beating expectations and only marginally down on the 5.4% of the previous quarter.

That suggests little fallout from US tariffs, so far at least.

The big issue remains the domestic property market. Falling property prices are undermining consumer confidence.

That’s making consumers less likely to splash out on big luxury items – like a holiday in New Zealand.

ANZ China chief economist Raymond Yeung says the process is well understood by the leadership and Beijing.

Speaking at last week’s China Summit in Auckland, Yeung said the leadership in Beijing is reluctant to provide support for the property market as it seeks to shift the investment mindset of Chinese consumers away from property.

There was a determination to wait it out while the market naturally rebalanced, but it was still about 18-24 months away from hitting bottom, Yeung said.

That suggests we shouldn’t be holding our breath for a Chinese-led recovery in our tourism sector any time soon.

Yeung, on stage with China foreign policy expert Andrew Browne, provided a fascinating session at the summit. I’ll use it for the basis of a feature-length look at China’s economy later this week.

Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003. To sign up to his weekly newsletter, click on your user profile at nzherald.co.nz and select “My newsletters”. For a step-by-step guide, click here. If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.