April Economic Update: Inflation quintuples within 6 months

Key highlights:
  • Inflation figures later this week will show a pace close to the mid-point of the RBNZ’s target.
  • But the RBNZ will still keep a close eye out, as inflation pressures have yet to show signs of becoming widespread.
  • Dairy prices are set to have a stronger auction result.

The RBNZ could be marking off a key milestone on Thursday. We expect annual inflation to hit 2.1% or Q1, the first reading at or above 2% since 2011 when the impact of the late 2010 GST increase as still washing its way through. 2% is the mid-point of the inflation target band, so hitting around that figure marks a return to a more ‘normal’ pace. Just 6 months earlier inflation was a mere 0.4%. 

Does that mean the RBNZ can go on holiday with the job done? Potentially the current Governor will, given he has less than 6 months to go until he steps down. But his successors will still need to be vigilant to ensure inflation holds up around this rate. Some of the factors contributing to inflation’s estimated 0.9% quarterly rise are one-hit wonders rather than inflation pressures that will be sustained. Petrol prices lifted an estimated 6% over the quarter, though have broadly stabilised since. Food prices have soared more than they usually do for the time of year – for those of you wanting to see better in the dark, a kilo of carrots cost $3.53 this February against $2.34 the year before. And a further 10% tobacco tax excise increase rounded out the bumps.

There are some signs of capacity pressures emerging in the inflation figures. Construction costs remain one. And pressures in service sector catering to the strong tourism market are another, with accommodation costs the most notable example. A degree of pricing power is also returning to some retail segments.

But capacity pressures are yet to become widespread, and nominal wage inflation is still modest. There is a long way to go before the RBNZ will be confident inflation will be able to sustain a pace near the target mid-point. And the inflation rate is likely to dip back towards 1.5% by this time next year, as the recent one-off lifts fade. So the RBNZ will be watchful for a while yet in case inflation doesn’t hold up. For that reason we expect the RBNZ will be comfortably on hold until late 2018. That will give the next permanent Governor plenty of time to get his or her feet firmly under the desk.

Dairy prices will also be in focus again this week. NZ has been battered by the weather over the past month, which will raise some question marks over the impact on dairy production. At this point it appears the impact has been localised and small, with major dairying regions avoiding the brunt. There may be near-term challenges to harvesting maize and re-grassing pastures. But water sources have been well and truly replenished, potentially setting up for a good spring. We expect whole milk powder prices to lift around 6-8% in Tuesday night’s auction.


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