Why NZ interest rates will not follow inflation higher

Inflation perked up in the March quarter and appears destined to breach the Reserve Bank’s target of 2 per cent by mid-year, but that doesn’t mean interest rates are going anywhere, any time soon.

Higher prices for transport and housing drove the consumers price index up by 0.8 per cent in the March quarter – in line with market expectations.

It compared with a 0.5 per cent increase in the December quarter, Stats NZ said.

The annual increase was 1.5 per cent, still a way off the Reserve Bank’s 2 per cent target, but economists say it won’t be long before inflation breaks higher.

Some are picking annual inflation will hit 2.5 per cent mid-year.

The question is how long will that spike last. For the moment, the view is that it won’t.

The Reserve Bank had forecast a quarterly gain over the March quarter of 1 per cent, so the inflation outcome endorses the central bank’s highly accommodative, “on hold” stance more than ever before, one market strategist said.

The bank targets annual inflation to be within a 1 to 3 per cent range, with a 2 per cent mid-point, and has maintained a very low 0.25 per cent official cash rate since March last year to try and soften the economic impact of Covid-19.

In its data release, Stats NZ said transport prices rose 3.9 per cent, the biggest quarterly rise in more than a decade.

Petrol prices rose 7.2 per cent, the biggest quarterly rise since June 2015.

Despite this, petrol prices are 3.8 per cent lower than they were a year ago, the department said.

Rent prices rose 1.0 per cent, the biggest quarterly increase in a year.

Capital Economics Ben Udy said “looking through the noise” of the data, inflation appeared subdued.

“Looking ahead, headline inflation will surge in Q2 as the weakness in prices last year becomes the base for the annual comparison.

“But we expect underlying inflation to remain close to the mid-point of the Reserve Bank’s 1-3 per cent target for the foreseeable future,” he said.

“That’s why we think the RBNZ will hike rates next year,” Udy said.

ANZ said inflation is currently being supported by a number of factors that are likely to prove temporary.

Higher oil prices and supply-chain disruptions have pushed up goods import prices and shipping costs, while the lack of migrant workers has led to higher-than-otherwise labour costs in some areas, the bank said.

“This is likely to see inflation break above 2 per cent over mid-2021, but we expect inflation pressures to ease once these drivers fade.”

It was always going to be a high hurdle for today’s data to shift the Reserve Bank from their ‘watch, worry and wait’ stance, ANZ said.

Details of this release were unlikely to challenge the central bank’s view that ongoing stimulatory monetary policy settings will be needed to generate a sustained return to 2 per cent CPI inflation, it said.

Kiwibank chief economist Jarrod Kerr expected annual headline inflation to overshoot the Reserve Bank’s 2 per cent target midpoint, temporarily.

“Annual figures in the next (June) quarter will be especially strong due to base effects of a weak quarter last year when prices fell. Inflation could spike to 2.5 per cent.

But the coming acceleration in inflation should prove temporary,” Kerr said.

“Bottlenecks at our ports will eventually be addressed. Strip away the volatility and core inflation remains subdued,” Kerr said.

“The economy is not yet strong enough to generate a sustained lift in prices. There’s still some spare capacity out there. When setting monetary policy, the Reserve Bank should look through the rise, just like every other central bank.”

Westpac senior economist Satish Ranchhod also expects annual inflation to push higher, mid year.

Global production levels have been ramping up in recent months, and the disruptions to local and international distribution networks will eventually clear, Ranchhod said.

He said the reinforced Westpac’s view that the official cash rate would remain on hold “for an extended period”.

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