Inflation expected to be contained after painful adjustment

Reserve Bank officials may be tempted to take a victory lap or at least crack open a bottle of (cheap) champagne this Wednesday after the release of the latest quarterly consumers price index (CPI) data.
Inflation is widely expected to finally be back within the RBNZ’s target range of 1-3 percent for the first time in more than three years; an outcome that was somewhat pre-empted by last week’s widely expected decision to cut the official cash rate by half a percentage point to 4.75 percent.
It has taken a painful adjustment in interest rates for borrowers to reach this point involving a total of 12 rate hikes beginning in October 2021, when the OCR had been cut to a record low of 0.25 percent in the wake of the Covid-19 pandemic, and concluded with the most recent 25 point hike in May last year that took the rate to a 16-year high of 5.5 percent.
Savers, on the other hand, have enjoyed a significantly more attractive return on their funds in recent years than they have for a long time, though those days look to be fast drawing to a close.
Though the RBNZ has forecast a quarterly rise of 0.8 percent in the consumers price index, Westpac economists’ estimate is slightly below that at 0.7 percent underpinned by three key upside inputs.
Annual increases in local council rates (3 percent of the CPI) are expected to be the largest contributor to the rise in consumer prices. Rates are estimated to have risen by an average of 10 percent over the last year, with large increases spread right across the nation.
Food prices (19 percent of the CPI) will also be a large contributor to quarterly inflation, with Stats NZ’s monthly prices data pointing to a 1.2 percent rise over the last three months. That includes a seasonal increase in the cost of fresh vegetables.
Insurance costs (three percent of the CPI) are also expected to post another large rise of 4.2 percent. Although still elevated, it’s more modest than the large increases seen in recent quarters, reflecting the fact that many insurance contracts have already rolled on to higher premiums over the last year.
On the downside, petrol prices (4 percent of the CPI) have trended down over the last few months and are estimated to have fallen 6.5 percent over the quarter, while softness in the prices of many imported durable consumer goods is expected to see prices for new and used cars for instance falling by 1 percent and 1.5 percent respectively.
Having achieved its objective, the Reserve Bank will now be on the lookout for inflationary pockets that might once again stoke inflation.
Though petrol prices in particular have been trending lower this year, a sharp uptick in recent weeks that has oil on track for its biggest monthly increase in more than a year following escalating Middle East tensions will have the central bank on high alert should prices continue to accelerate, according to BNZ economist Doug Steel.
“The recent volatility in crude oil prices which, combined with some recent easing in the NZD, is putting upward pressure on domestic fuel prices, [an issue] the RBNZ may choose to look through for now but will no doubt be alert to any meaningful influence on the likes of inflation expectations.”
And the ferocious storms that have devastated Florida in the last few weeks, and also here in recent years, are a reminder of the ongoing inflationary impacts of climate change and the effect it has on the likes of insurance premiums in the future.
But the question that has received little attention to this point, given that interest rates are now rapidly falling, is: where’s the bottom?
As The Economist noted recently, in the US the views of the influential Federal Reserve’s Monetary Policy Committee are the most dispersed since the Fed started publishing its “dot plot” projections in 2012 where individual officials outline their forecasts for rates each quarter.
Of the 19 who made forecasts last month, a maximum of three agreed on any level for long-run rates. In all they made 11 different forecasts, from a low of 2.375 percent to a high of 3.75 percent.
Such a wide range obviously reflects a high degree of uncertainty about the future outlook. It also points to a fundamental problem with monetary policy: the extreme fuzziness of determining the neutral rate of interest that is deemed to be neither expansionary nor contradictory.
It seems hiking rates to achieve an upper limit of contraction may be easier than cutting them when the neutral rate remains uncertain and unknown.
As The Economist concluded “aiming for an imaginary and almost certainly false variable is just as likely to hurt as to help. In that sense, the collapse of consensus in the Fed’s neutral projections is welcome. It is a form of intellectual honesty.”
No doubt the Reserve Bank here will have to start grappling with exactly the same issue. Just how far and how much do you cut rates from here?
Borrowers, meanwhile, will just be hoping there are still plenty more interest rate cuts still to come; while savers, of course, will be wanting the opposite.
It seems central bankers face a new challenge: keeping inflation contained while navigating increasingly uncertain times. Though if they have learned one thing from their stimulus efforts in the wake of the Covid pandemic it might be not to underestimate how quickly inflation can take hold. ‘Transitory’ is likely to be a word they use much more cautiously in the future.
The NZ sharemarket continued to push higher buoyed by last week’s jumbo OCR cut by the Reserve Bank that has breathed new life into a market that has regained new momentum in the second half.
The NZX50 is now on the brink of entering double figures for its year-to-date advance after finishing on Friday with a gain of 9.5 percent for the year, and now looks to have 13,000 in its sights by year-end. Contrast that with where the market was at just a few months ago in early July when the index had barely gained 1 percent year-to-date and its obvious investors are increasingly feeling more positive about the outlook for next year.
Adding to cuts in interest rates, plans by Chinese officials to boost its flagging economy are likely to benefit local exporters given China’s status as NZ’s biggest trading partner (see below).
The September BusinessNZ Performance of Manufacturing Index also continued to improve, albeit slowly, increasing to 46.9, up from 46.1 in August, indicating the sector was maintaining higher levels of activity. (A reading below 50 indicates contraction.)
BusinessNZ’s Director of Advocacy, Catherine Beard, said the good news was the PMI was now at its highest level since April, though on the flipside it would likely be a long and slow road to get the sector back into positive territory.
“The key sub-index results for Production (48.0) and New Orders (47.8) were the highest since April 2024 and November 2023 respectively, while Finished Stocks (46.6) also nudged up from the previous month. However, both Employment (46.6) and Deliveries (45.6) were slightly down from August,” Beard said.
The results of the accompanying Performance of Services index will be released today.
In other market developments, Fletcher Building completed its $700m capital raise after attracting a further $113m in its retail entitlement offer. Its shares ended the week at $3.09 after climbing as high as $3.28 at one point.
Tower significantly upgraded its full-year net profit guidance to $83m, up from greater than $45m previously, as a result of no large events occurring in the current financial year, while broadband network provider Chorus told the market its total fibre connections increased by 8,000 in the quarter ending September. The network footprint now includes 1.514 million addresses.
In the US, markets continued to show signs of nervousness about the outlook for inflation after the September consumers price index showed the annual rate at 2.4 percent, down from the previous 2.5 percent but a little higher than the expected 2.3 percent forecast. The news suggests the Federal Reserve is unlikely to cut its cash rate by a further 50 points and will probably opt for a lesser 25 point cut next month.
The news pushed the US 10-year treasury yield to a near three-month high of 4.1 percent suggesting investors believe the Fed may not be able to cut rates as aggressively as had earlier been expected.
After another volatile week in which Chinese stocks fell sharply after a more than 20 percent gain the previous week, on Saturday government officials announced that more debt would be issued to boost its troubled property market, recapitalise banks and help cash-strapped local governments, as Beijing seeks to reassure investors over its efforts to boost its underperforming economy.
Announcing the measures, Minister of Finance Lan Fo’an gave few details regarding the amount of funding being proposed but suggested that the government plans more stimulus measures to shore up growth.
“Our countercyclical adjustment goes far beyond what I have mentioned,” Lan told reporters, adding that more steps were under discussion. “The central government, when it comes to increasing the deficit and increasing debt, [has] significant room.”
Markets have been anxiously waiting for signs that Beijing will increase fiscal spending to back up monetary stimulus plans, amid persistent doubts over the strength of the world’s second-largest economy.
Stocks in China plunged last week after state planners held a press conference on the economy but failed to give details of stronger fiscal support.
Lan said Beijing would issue bonds to enable local governments to buy back idle land from developers as well as some of China’s millions of unsold new homes. The government will also issue a special-purpose bond to help large banks replenish their capital, which would enhance their ability to lend.
Other groups such as low-income earners and students, who have been particularly hard hit by a weak job market, also stand to benefit from the planned stimulus efforts.
The latest announcement to boost China’s flagging economy follow declining household and stock market confidence on the back of a prolonged property sector slowdown and state crackdowns on sectors such as e-commerce and finance.
The measures, which included extensive support for the stock and property markets, drove the benchmark CSI 300 index up 24 percent before a week-long national holiday. But markets tumbled again on reopening last week after disappointment with the state planners’ briefing.
One investment strategist told the Financial Times the series of press conferences from economic planners indicated a “fundamental shift” on the economy by China’s leader Xi Jinping to restore confidence among consumers and entrepreneurs.
Economists have estimated that China needs to spend up to Rmb10 trillion ($1.4tn) over two years on additional stimulus measures to reflate the economy, adding that much of it needed to be directed at households to shore up domestic demand.
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