Weekly Economic Commentary 22 April 2024
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
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The RBNZ can’t shake off the strength in domestic inflation
Inflation in New Zealand has been dropping back as domestic demand has cooled. However, that softening is occurring more gradually than the RBNZ has been expecting. Importantly, a hard ‘sticky’ core of domestic inflation pressures means a return to 2% inflation is still a long way off. Against that backdrop, the RBNZ is set to leave the Official Cash Rate on hold over the remainder of this year.
New Zealand consumer prices rose 0.6% in the first three months of the year. That saw annual inflation dropping from 4.7% at the end of last year to 4% now. That’s the lowest annual inflation has been since June 2021.
The March quarter inflation outcome split the difference between our forecast for a 0.8% increase and the RBNZ’s forecast for a 0.4% rise. The RBNZ’s forecast was finalised back in February, and their April policy statement signalled that they were already braced for an upside surprise on the day. Even so, the underlying details of the latest inflation figures were likely to have been uncomfortable reading for the RBNZ.
The downturn in inflation has almost entirely been a result of softness in the prices of tradable goods (sometimes referred to as imported inflation). This was also the area that accounted for our forecast miss. Tradable prices fell 0.7% over the March quarter, with sharp falls in the prices of items like used cars and apparel. Those falls more than offset the 6.8% rise in the cost of holiday accommodation as many ‘Swifties’ flocked across the Tasman for Taylor Swifts’ February concerts in Sydney and Melbourne.
On an annual basis tradables inflation has fallen from 3.0% at the end of 2023 to 1.6% now. That decline is partially a symptom of the downturn we’re seeing in retail spending, with households dialling back their spending in many discretionary areas such as apparel, furnishings, and appliances. That’s a sign that monetary policy is working to restrain demand.
We expect continued softness in spending and retail prices over the year ahead. However, we don’t expect a further significant drop in tradable inflation from here. Tradables inflation peaked at close to 9% in response to surging domestic demand and pandemic related disruptions to supply chains. As the impact of those influences has passed, tradables has fallen sharply, with outright falls in prices over the past six months. Going forward, quarterly tradables inflation is likely to remain weak (averaging close to zero), but we’re not likely to see further substantial declines, especially with the NZ dollar losing ground.
It’s a starkly different picture when we look at the domestic parts of the inflation story. Non-tradable prices were up 1.6% in the March quarter – higher than our own forecast (+1.4%) and much hotter than the RBNZ’s forecast for a 1.1% rise. Non-tradables inflation has now surprised the RBNZ on the upside for four consecutive quarters. There is not yet substantive signs of a trend decline in non-tradables inflation on a quarterly basis.
On an annual basis, non-tradables inflation remains red-hot at 5.8% in the year to March. Notably, non-tradables inflation excluding construction costs remains elevated at 6.3% and it has eased only slightly since the RBNZ first raised the OCR back in 2021. The past year has seen big increases in some specific areas like housing rents, insurance, and local council rates, but cost pressures have been widespread. Consistent with that, measures of core inflation are continuing to run at rates of around 4%, with measures of domestic core inflation around 6%.
Key to determining what happens with domestic inflation and demand more generally will be the strength of the labour market and wage growth. With economic activity turning down over the past year, we have seen some softening on this front. Jobs growth has slowed, and staff turnover has fallen as workers have become increasingly concerned about job security. Consistent with those conditions, businesses have been reporting that the strong wage pressures we’ve seen in recent years are starting to ease. However, that easing in the labour market has been from a very stretched position. At 4%, the unemployment rate remains historically low. And thus far, the adjustment in the labour market has proceeded more slowly than the RBNZ has expected.
We expect that the jobs market will continue to soften over the year ahead with unemployment expected to gradually rise to 5% by the end of the year. While that will certainly be tough for the affected families, that would still be a relatively modest slow down compared to previous downturns (for instance, in the wake of the Global Financial Crisis, unemployment peaked at 6.7%). Consistent with that, we expect wage growth, and hence inflation in services sectors, will ease only gradually.
That stickiness in non-tradables inflation will be a big concern for the RBNZ. Overall inflation is easing and is on course to fall below 3% in the second half of this year. However, with persistent strength in domestic inflation, it will be a long time before we’re back at 2%. And that also means that rate cuts are still a way off. We continue to expect that the OCR will remain on hold until early 2025. The inflation data won’t have encouraged the RBNZ to bring forward their estimated timing of when easing might occur and indeed the forecast OCR profile likely moved back closer to the relatively hawkish stance taken in November last year. Market pricing has been moving in that direction also. Until recently, financial markets had been pricing in rate cuts in New Zealand from August. However, in the wake of inflation data – both here and in the US – expectations for an August rate cut have been priced out, while a cut in October is around 80% priced.
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