Thursday, April 19, 2012

NZ Inflation and Monetary Policy

New Zealand March quarter consumer price inflation came in around market expectations at 0.5% for the quarter and 1.6% for the year. This was lower, however, than the Reserve Bank of New Zealand (RBNZ) expectations of +0.7% and +1.8% respectively.

There is no doubt that inflation pressures are currently contained. This latest result follows the much lower than expected -0.3% quarterly out-turn in December. Furthermore, annual inflation appears likely to move even lower in the following quarter. Our forecast of 0.6% for June quarter inflation would see the annual CPI move lower again to 1.3% for the year to June.

Over the quarter excise increases (alcohol and tobacco) and rentals (Christchurch) were the major upward influences. The strength of the exchange rate has been the dominant downward factor over recent quarters with tradeables inflation recording declines over the last two quarters (-0.9% in December and -0.4% in March). The annual rate now stands at +0.3% for the year to March. By way of comparison, annual non-tradeable inflation (the best estimate of purely domestic inflationary pressures) is up 2.5% in the year to March.

Recent low inflation results, along with lower than expected December quarter GDP growth, has justified the RBNZ (and market) progressively shifting out expectations of when it will be appropriate for monetary policy to start becoming less stimulatory. We agree with the RBNZ’s bias to tighten: we believe that inevitability can only be delayed for so long.

By later this year, we expect there will be signs of capacity constraints building. Indeed, capacity utilisation is already running ahead of its long-term average. We continue to watch indicators of skills shortages in the labour market, as we believe that will be the area in which inflationary pressures emerge first. Also the downward impact of the high exchange rate on inflation will continue to moderate over the next quarter or so (assuming it doesn’t move significantly higher) and could soon have the opposite impact of contributing to higher inflation as the NZD inevitably (in our view) falls.

We continue to expect the RBNZ to start tightening later this year with the OCR likely to move from 2.5% to 3.0% in December. We think the neutral official cash rate is now around 4.5%, helped by the fact that fiscal policy looks likely to be contractionary in the period ahead. That’s considerably lower than it was pre-GFC (6%), but a not insignificant 2 percentage points away from where the OCR is today. By the time less stimulatory monetary conditions are required, the Bank will need to get on with the job. We think the OCR will be at 4.5% by late 2013.