ANZ economists caution the Reserve Bank against making another false move against anticipated inflation

By David Hargreaves

ANZ’s economists are warning the Reserve Bank against any early, overly pre-emptive strike against anticipated inflation.

In a preview of December quarter Consumers Price Index figures due to be released by Statistics New Zealand on January 26, ANZ senior economist Philip Borkin says inflation pressures should continue to gradually build over 2017.

ANZ’s picking 0.3% inflation for the December quarter, which is above the RBNZ’s pick of 0.2%. The ANZ is further picking annual inflation to lift to 1.2%, which would get it back into the RBNZ’s targeted level of 1%-3% for the first time since the third quarter of 2014.

“Deflationary influences are certainly still present (NZD, technology, competitive retail environment etc), which will ensure inflation doesn’t run away,” Borkin says.

“But these factors are expected to be increasingly usurped by traditional demand-pull forces and the simple mechanics of falls in oil (petrol) prices being replaced by increases.

“Inflation has been a missing element of the expansion to date, but evidence is building (rising firm pricing intentions, positive output gap, tighter labour market, stronger global inflation etc) that it is now starting to return. The Q4 inflation figures will be a step in that direction.”

But then comes the cautionary note.

“However, that doesn’t necessarily suggest that the [Official Cash Rate] should follow inflation upwards in quick succession,” Borkin says.

“Given two false starts to tightening since the financial crisis, the hurdle for lifting the OCR should be high.

“The RBNZ needs (and will likely want) to see the whites of the eyes of inflation before tightening, rather than risking taking another pre-emptive strike that eventually proves unwarranted.”

As Borkin says, after dropping the OCR to a then record low of 2.5% in early 2009 in response to the effects of the Global Financial Crisis, the Reserve Bank has twice started tightening cycles that have subsequently needed to be aborted.

In both June and July 2010 it lifted the OCR by quarter of a percentage point, and then reversed this in a single 50 bps drop in March 2011 after the second of the Christchurch earthquakes.

Then there were four 25 bps hikes in the first half of 2014, which began being reversed a year later. The OCR now stands at just 1.75%. 

In terms of the expected inflation outcome next week, Borkin says higher petrol prices and base effects largely account for the lift in annual inflation.

“Retail fuel prices are estimated to have risen by 5% over Q4, in stark contrast to the 7% drop seen in the same quarter a year earlier. This results in a mechanical bounce in annual CPI inflation. New Zealand is not unique in this phenomenon; headline inflation is rising globally as oil prices stabilise after the late 2015/early 2016 falls.”

Borkin says that more importantly, there should be further evidence of a turn in the domestic inflation cycle.

“While non-tradable inflation, at an estimated 0.5% q/q (2.3% y/y), is still low historically, it is trending higher and we see risks skewed to a modestly stronger outcome in Q4. Our Monthly Inflation Gauge is hinting at price increases beyond just housing, which is consistent with growing capacity strains across the economy.”

Borkin says that tradable inflation should remain soft, however, at -0.1% q/q and ‑0.5% y/y.

“While still negative, this would represent the highest annual tradable inflation since Q2 2014, largely reflecting petrol prices. Outside of petrol, tradable inflation is expected to print at -0.7% q/q (-0.5% y/y).”