Friday, January 18, 2013

New Zealand inflation lower than expected...again

New Zealand’s Q4 2012 Consumer Price Index was softer than expected, coming in at -0.2% for the quarter and +0.9% for the year.  The annual rate ticked up slightly by virtue of a slightly larger negative from the fourth quarter of 2011 falling out of the annual calculation. 

A low number for the quarter was not a surprise.  Market expectations were for an increase of 0.1% for the quarter, while our view was that something close to zero was probably about right, especially given heavy price discounting in the lead up to Christmas. 

The surprise for me was the split between tradeable and non-tradeable inflation.  Non-tradeable inflation came in at +0.3% for the quarter and +2.5% for the year while the outcome for tradeable inflation were -0.7% and -1.0% respectively.  Thus the key disinflationary factor in the New Zealand economy right now is the on-going strength of the New Zealand dollar, alongside weaker commodity prices last year.

This result will undoubtedly lead to further calls for cuts to interest rates.  Unfortunately those calls are missing the point.  The key factor driving the New Zealand dollar right now is the not interest rate differentials, it’s the fact that commodity prices are still relatively high, the global economy appears to be recovering and many of the countries whose exchange rates make up are Trade Weighted Exchange Rate Index (TWI) are undertaking quantitative easing.  Cuts to interest rates here will not, in my view, lead to a lower New Zealand dollar, at least not a sustained decline.

Furthermore, cuts to interest rates now will provide further heat to an increasingly stretched housing market.  The good thing about the current strength in the market, especially Auckland, is the problem is due to a shortage of supply rather than what would be the more worrisome problem of speculative demand, although one can soon become the other.

Of course house prices themselves do not feed into the CPI directly, but construction costs do.  Even then, that component of the CPI rose an only modest 0.6%.  I wouldn't have been surprised to see a higher number.  Nevertheless, the Reserve Bank will be watching closely.

Today’s result does not change my view, nor I expect the Reserve Bank’s, that the next move in interest rates is up; the only question is when?  Economic growth is picking up, largely driven by the construction sector.  Latest reads on both business and consumer confidence support that view, as does rising capacity utilisation. 

We think GDP qrowth will be around 2.8% in 2013, up from 2% this year.  With potential GDP at around 2% per annum (lower than it once was), I still think the time will be right in the second half of this year to start removing some of the monetary stimulus.