Weaker-than-expected inflation unlikely to stop rate hikes

The annual inflation rate is expected to have remained stubbornly high, at around 7 per cent, in the March quarter.

Economists believe Stats NZ data due out on Thursday morning will show prices rose at a similar, or slightly slower, rate between the March 2022 and March 2023 quarters as they did in the previous two quarters.

Westpac economists see the annual inflation rate coming in at 6.9 per cent; BNZ and Kiwibank economists forecast 7.1 per cent; and ANZ and ASB economists 7.2 per cent - the level it was in the December and September quarters.

While all these forecasts undershoot the 7.3 per cent projection the Reserve Bank (RBNZ) made in February, a little bit of softness isn’t expected to stop the central bank hiking the official cash rate (OCR) one more time.

Economists from all the major banks expect the RBNZ to lift the OCR by 25 points, to a peak of 5.5 per cent, at its next review on May 24.

Even if the inflation reading isn’t as bad as expected by the RBNZ, the rate will still be well beyond its 1 to 3 per cent target range.

Economists believe the RBNZ will be mindful of not giving the impression it’s weakening its battle against inflation. If businesses expect inflation to persist and their costs to keep rising at a rapid rate, they’d keep lifting their prices accordingly, exacerbating the problem.

Furthermore, as the RBNZ said at its last OCR review a fortnight ago, it’s wary of falling wholesale rates prompting banks to drop their retail rates before economic demand has been dampened enough to lower inflation.

“Despite growing downside risks, the prospect of inflation being slow to fall below 3 per cent should keep the RBNZ cautious, with its least regret still hingeing on doing too little on OCR settings rather than too much,” ASB senior economist Mark Smith said.

The economists at all the major banks believed the RBNZ would be particularly concerned about domestically driven, or “non-tradeable”, inflation.

“Inflation pressures remain red hot,” Westpac senior economist Satish Ranchhod said.

“With elevated levels of demand over the past couple of years, capacity in the labour market and the economy more generally have become stretched. That’s meant that price rises have become increasingly widespread, with businesses in many parts of the economy reporting large increases in operating costs.”

ANZ senior economist Miles Workman went so far as to say: “Long after high global inflation (ie tradable) pressures have come down to earth, there is a real risk that domestic inflation proves sticky at high levels, potentially necessitating another round of rate hikes after the RBNZ has held the OCR at its “watch, worry and wait” level [of 5.5 per cent] for a few quarters.”

Workman forecast quarterly tradeable and non-tradeable inflation both coming in at 1.7 per cent.

Looking at the details, lower oil prices saw prices at the petrol pump fall by about 4 per cent over the March quarter, according to Ranchhod.

Nonetheless, food prices rose by 3.7 per cent, thanks to extreme weather events, rising input costs, geopolitical tensions and labour shortages.

Meanwhile, rents rose by 0.9 per cent and construction costs are expected to have lifted by 1.8 per cent.

Looking at the impact of Cyclone Gabrielle, Smith noted the RBNZ believed the impact was likely to be more inflationary than it expected when it released its forecasts in February.

“This could well be the case, and we envisage construction costs, dwelling maintenance services, prices for cars, insurance premiums and dwelling rental inflation to be pushed up,” Smith said.

“There is also the risk that more supportive fiscal settings could add to inflationary pressures.”

Indeed, Workman concluded the inflation data wouldn’t be the “final word” on the RBNZ’s next OCR review on May 24.

“The Q1 labour market release and Budget 2023 are yet to come, and both could easily end up on the more inflationary side.”