Rising prices a risk to Reserve Bank’s effort to avoid inflation danger zone

• Economists expect annual inflation to reach 2.8% or 2.9%, nearing the Reserve Bank’s target upper limit.
• Despite rising inflation, further interest rate cuts from the Reserve Bank are still anticipated.
• Non-tradable inflation is easing gradually, but domestic inflation remains above historic averages.

Economists expect today’s Consumers Price Index numbers will show annual inflation moving dangerously close to the upper end of the Reserve Bank’s target band, near 3%.

But despite that, further interest rate cuts from the Reserve Bank are still on the cards.

Expectations are that the annual figure will land at 2.8% or 2.9% for the year to June, up from 2.5% in the year to March.

“June Selected Price Indexes support our view that inflation will print above the RBNZ’s forecasts and [this] sets up a further nudge higher in [the third quarter],” said BNZ head of research Stephen Toplis.

“The balance of the volatile monthly prices came in a touch stronger than our assumptions for the month, although not enough to alter our pick.”

BNZ is picking a 0.8% rise for the quarter for an annual rate of 2.9%.

“This is stronger than the RBNZ’s May forecast of 0.5% [quarter on quarter] and 2.6% [year on year],” Toplis said.

“The RBNZ openly acknowledged near-term inflation upside in its July MPR [Monetary Policy Review], noting that ‘inflation is expected to increase further in the June and September quarters toward the top of the MPC’s inflation target band’. And the bank still confirmed an easing bias,” he said.

“So higher near-term inflation remains a risk to monitor but need not necessarily derail further reduction in the OCR if the RBNZ continues to look through the near-term pressure and focus on a subdued medium-term outlook.”

Despite the risks, inflation would need to come in much worse than expected to prevent another OCR cut in August, said ANZ senior economist Miles Workman.

“The RBNZ will need to balance any upside surprise in the CPI against the signal from the high-frequency data, which is currently pointing to a stalling recovery and therefore downside risks to the medium-term inflation outlook,” he said.

“Given this, we think it would take a sizable upside surprise in the CPI to take an August cut off the table.”

Westpac’s Satish Ranchhod highlighted the contrasting trends for tradable inflation (internationally priced goods like petrol and food) and non-tradable inflation (domestically priced goods and services like rents and labour costs).

“In terms of the big CPI groups, we expect that domestically oriented non-tradables prices will rise 0.7% over the quarter,” he said.

“That would see annual non-tradables inflation slowing to 3.8%, down from 4% last quarter and continuing the gradual easing that we’ve seen over the past couple of years.”

Non-tradable inflation traditionally runs higher than tradable inflation.

“Underlying that easing in domestic inflation has been softness in economic activity, which has seen muted growth in wages and service sector prices,” Ranchhod said.

“We’ve also seen very limited increases in both rents and the cost of new housing (the latter reflecting the more general softness in the housing market).”

But even with that softness in domestic activity, overall non-tradables inflation was easing only gradually because of lingering strength in administered prices, like electricity charges, he said.

Those increases meant domestic inflation is lingering above historic averages, and that would be a key concern for the RBNZ.

“On the imported front, we expect tradable prices will rise by 0.3% in the June quarter,” he said.

“That would see annual tradables inflation rising to 1.2% – a stark change from the past year when tradable prices had been flat or falling.”

For the Reserve Bank, the focus would go to core inflation, which tracks underlying trends by stripping out volatile goods like petrol and food.

“Core inflation measures have been trending down in recent months and have drifted back towards or inside the RBNZ’s target band,” Ranchhod said.

“We expect that core inflation will continue to gradually ease in June but will linger above 2%.”

The main uncertainty around forecasts would be prices for discretionary household items, with the risks here on both sides, he said.

Those items are mostly imported and include products like apparel, furnishings and other durable items.

“Household spending has been subdued in recent months, and that could have an even larger dampening impact on prices than we had assumed.

However, prices for some items, like cars, can have sizeable swings on a quarter-to-quarter basis.”

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.