New Zealand’s March quarter CPI came in lower than expected at +0.3% q/q/ for an annual rate of +1.5%. That’s a tad lower than the 1.6% recorded for the year to December. Market consensus was for a quarterly increase of +0.5% and an annual rate of 1.7%. However, we don’t expect the Reserve Bank of New Zealand (RBNZ) to be in any way deterred from continuing the gradual removal of monetary accommodation in the months ahead.
The surprise in the result was the softness in tradeables inflation
which came in at -0.7% q/q and -0.6% y/y with the downward pressure on prices coming
from the strong New Zealand dollar. That
decline was more than offset by a 1.1% q/q increase in non-tradeables inflation
which is now running at an annual rate of 3.0%.
Key contributors on that side of the equation were the expected increase
in tobacco excise tax, but also continued strong increases in construction
costs which are now running at an annual rate of 5.1%.
We don’t expect this result to deter the RBNZ from pressing ahead with
the gradual withdrawal of monetary stimulus.
The reality is that GDP growth is running well ahead of potential, spare
capacity is being absorbed and firms are finding it more difficult to find
skilled labour and interest rates are still at exceptionally low levels.
Those factors being the case we still expect the RBNZ to lift the
Official Cash Rate 25bps in each of April, June, September and December for an
OCR of 3.75% by the end of this year, with continued tightening in 2015 taking
the OCR to 5.25%.
That said, there
are many factors that will ultimately determine the quantum and pace of the
tightening cycle. These include whether the RBNZ has been (and remains) sufficiently
pre-emptive, how the economy responds to higher rates, where the neutral OCR
is, what New Zealand potential growth rate is and, of course, the path of the
With respect to the exchange rate our interest rate forecasts
assume some eventual downside in the New Zealand dollar. Recent falls in commodity prices haven’t yet
proven the catalyst for a weaker currency but we expect that as the Reserve Bank of
Australia starts to hike rates later this year and as the US Federal Reserve
moves closer to interest rate increases we will see some downside in the
NZD. If none of those work, the
catalyst for the lower NZD will likely prove to be a downward revision of our
and, more importantly, the Reserve Bank’s interest rate projections!
But remember exchange rate risks are not one-sided. A sharper than expected fall in the exchange rate could lead to higher inflation and higher interest rates.