CPI inflation of 2.2% in year to March beats expectations, with housing-related and transport prices on top of cigarette tax rise driving it

Prices rose at their fastest rate in five years during the last 12 months as housing-related costs such as new builds and rentals, transport costs and a cigarette tax hike helped push up the cost of living.

Consumers Price Index (CPI) figures released by Statistics NZ showed an annual increase of 2.2% in the year to March 2017. This was above market expectations of a 2.0% rise. CPI inflation in the March quarter was a whopping 1.0%, adjusted for seasonal effects.

The New Zealand dollar rose 0.4 of a cent against the greenback to US70.4 cents on the news. Read economist reactions below. Capital Economics said the data might spur the Reserve Bank to bring forward its own 2019 Official Cash Rate (OCR) hike track, while Westpac noted upside to their own late-2018 view. Infometrics said they are now expecting a May 2018 hike. Others were more wary on bringing forward exepectations from late-2018.

In its February Monetary Policy Statement, the Reserve Bank had indicated it expected annual CPI inflation of 1.5% for the year to March 2017, with a 0.3% quarterly rise. However, Governor Graeme Wheeler has since indicated CPI inflation might be impacted by variable one-off effects such as food and import price movements.

Economists have pointed out in recent days that the Reserve Bank had indicated it would look through what it may deem as any temporary rise in CPI inflation. In February, the RBNZ indicated it expected inflation to fall away again during the year to March 2018, to sit at 1.3% at that time.

Indeed, there was a catch in Thursday’s figures. Excluding the impact of petrol, cigarettes and tobacco, the CPI only rose 1.5% during the year to March 2017.

Tradeable prices (imports and local goods and services in competition with imports) rose 1.6% over the year, its highest since September 2011. Non-tradeable prices (such as newly built houses and other goods and services that do not face foreign competition) rose 2.5%.

And underlying CPI inflation – excluding extreme price rises and falls – showed an annual increase of about 1.0%. The CPI excluding housing and household utilities group increased 1.7%; excluding alcoholic beverages and tobacco it increased 2.0%; and excluding transport it rose 2.0%.

The central bank is mandated to pursue price stability, with a medium-term annual CPI inflation target band of 1-3%, with a 2% midpoint target. To do this, it seeks to manage monetary conditions in the economy with the Official Cash Rate. The Reserve Bank’s ‘average’ OCR track published in February indicated an expectation of 1.8% through to the September 2019 quarter, when it rises to 1.9% and then 2.0% in March 2020.

But the level of the upside surprise during the March quarter – everyone was already aware of the potential impact from variables such as cigarette and tobacco taxes – will no doubt have economists scrambling as to whether they need to rethink forecasts that the Bank would be able to hold the Official Cash Rate at 1.75% until late 2018.

Housing, transport and cigarette prices

“Rising petrol prices along with the annual rise in cigarette and tobacco tax lifted inflation,” Stats NZ prices senior manager Jason Attewell said Thursday. “Petrol prices in New Zealand are closely linked to global oil prices, and cigarettes and tobacco taxes rise in the March quarter each year,” he added.

Housing-related prices continued to increase, up 3.3% in the March 2017 year. Prices increased for newly built houses, excluding land (up 6.7%), and for housing rentals (up 2.3%). Newly built houses, excluding land, were up 8.0% in Auckland and 3.6% in Christchurch.

Transport prices rose 3.5%, with petrol (up 12%) partially offset by falls in other private transport services (vehicle relicensing fees), Stats NZ said.

Prices fell for broadband and cellphone plans, as well as handsets. Improvements to speed and data capacity improved the quality of the service, which is reflected as a price fall.

Tradeables vs non-tradeables

A key factor to low CPI inflation in recent years – the Reserve Bank has been heavily criticised for undershooting its 2% target – has been low or negative tradeables inflation. The 1.6% annual increase in March compared to a 0.1% fall in the year to December 2016 and was the highest annual increase for tradeables inflation since the September 2011 quarter (4.6%).

Meanwhile, non-tradeables CPI inflation of 2.5% in the year to March was similar to previous readings over the past five years.

Economist reaction – RBNZ’s own 2019 OCR track could come forward towards economist 2018 picks

The result means the Reserve Bank might not wait until its own 2019 track to lift the Official Cash Rate, Capital Economics’ head of Australia and New Zealand Paul Dales said in a note. “Underlying price pressures appear to be stronger than both we and the RBNZ expected,” he said. Capital Economics had picked a 2.2% overall annual rate. “The RBNZ didn’t expect inflation to be this high until sometime in 2020.”

“It was the strength of underlying inflation that caught our eye. The 0.5% q/q rise in core prices (exc. food and energy) was larger than the 0.3% q/q rise we had expected and left the annual growth rate at a three-year high of 1.6%. That’s a significant turnaround from 1.0% this time last year,” Dales said.

ASB economists said they still expected the next OCR increase to come in late 2018. “We expect the current lift in headline inflation will be temporary, as does the RBNZ, given there were several ‘one-offs’ in Q1,” they said. “Nonetheless, we expect annual inflation to hover around 1.5% and 2% over the next few years. As such, downside risks to inflation, especially those stemming from weaker inflation expectations, have significantly reduced over the past six months.”

They noted that the 2.2% rise in the Stats NZ trimmed mean and weighted median measures indicated CPI inflation was relatively broad-based. “The recent sharp recovery in inflation will come as a significant relief to the RBNZ. The lift has taken inflation expectations back to the middle of the target band with it, removing one of the RBNZ’s key concerns of recent years.”

Westpac economists said the stronger-than-expected result, including signs that tradables inflation may have more momentum than anticipated, “does suggest some upside risk to our view for the Official Cash Rate.”

“The key contributor to the March increase in the CPI was higher food prices. In particular, poor weather saw strong increases in some fresh produce prices. While we’ve seen some continued poor weather in the early part of the June quarter, this still represents only a temporary boost to inflation,” Westpac economists said.

“Of greater note was less-than-expected weakness in the prices of goods such as clothing and electronics. These are items that tend to be imported, and we had expected some softness given the earlier strength in the NZ dollar. However, those firmer prices may suggest that retailers are starting to rebuild margins off the back of solid domestic demand. Notably, business surveys signal that many retailers are looking to increase their prices further over the coming year.”

ANZ economists said the details were far more mixed than the headline figure suggested. “With the economy increasingly butting up against capacity pressures, we do expect domestic inflation pressures to broaden further beyond housing and into the labour market,” they said.

“However, there is still only modest evidence of this occurring at this stage (although the latest equal pay ruling should add some impetus). And with the impact of food and petrol price gains set to be temporary, and plenty of questions surrounding the global inflationary backdrop, it is certainly not guaranteed that headline inflation remains around current levels for a sustained period.

“Today’s data reinforces that the next move in the OCR will be up. While acknowledging the uplift in some core inflation gauges, we doubt there is enough evidence in the breadth of moves to spur the RBNZ into shifting its stance just yet, especially with financial and credit conditions tightening independently of the OCR.”

Kiwibank economists said the data was likely to be heartening for the RBNZ. “At 2.2% yoy March quarter CPI inflation is significantly above the RBNZ’s February MPS forecast of 1.5% yoy. However, several of the main price drivers at the start of 2017 are likely to prove relatively temporary,” they said.

“If we exclude the petrol price rise and the cigarette and tobacco excise tax, then the CPI would be at 1.5% yoy – still comfortably within the Bank’s target range but not showing any threat of running away. What’s important for monetary policy is the medium-term outlook. With the economy growing near trend we don’t expect inflation to pick-up significantly further from here given were we are in the current business cycle.”

Meanwhile, Infometrics economists also said the RBNZ was unlikely to stick to it’s September 2019 track. “We anticipate an earlier hike, and expect the Bank to begin ratcheting up the OCR from May next year,” they said.

The video above was produced by Stats NZ.