Transpower upgrade, food, building costs may mark otherwise tame second-quarter inflation

Monday 16th July 2012

Higher electricity costs, as power companies hike prices to pay for Transpower's grid upgrade, a jump in food prices and emerging pressure in building costs probably marked an otherwise tame pace of inflation in the second quarter.

The consumer price index rose 0.5 percent in the three months ended June 30, unchanged from the first quarter, according to a Reuters survey of 16 economists. That would see annual inflation slow to 1.1 percent, near the bottom of the central bank's 1 percent-to-3 percent target range, from 1.6 percent, giving the bank little reason to move quickly in raising interest rates.

Traders still see a small probability that the Reserve Bank will cut the official cash rate in the next 12 months, based on the Overnight Interest Swap curve, which shows 17 basis points of cuts priced in, according to Reuters data. Surprisingly strong food prices, which jumped 1.4 percent in the latest quarter, may push CPI up more than expected in a quarter Westpac Banking Corp says was dominated by a spike in energy prices.

Westpac economist Michael Gordon forecasts energy prices jumped 3.9 percent last quarter, the biggest quarterly increase on record, resulting from "a significant increase in electricity line charges to fund major investment in the national grid."

Still, "subdued inflation will be the theme for a while longer," Gordon said in his CPI preview. "Cost pressures generated by the Christchurch rebuild will become a more significant factor over time, although the weak starting point for inflation means that the RBNZ will be in no hurry to start pre-emptively leaning against these pressures."

While the market has been in step with the Reserve Bank's thinking on inflation in the first half of 2012, some disagree with the bank's prediction of a pickup in the CPI to 0.7 percent in the third quarter.

Bank of New Zealand economist Craig Ebert says annual inflation could slow to 0.9 percent in the third quarter, falling out the back door of the Reserve Bank's target range for the first time. He attributes this to the New Zealand dollar staying stronger than the central bank is predicting, and keeping a lid on imported inflation.

The trade-weighted index, the bank's preferred measure of the kiwi, ended up at 72.31 at the end of last week, having recovered from as low as 68.36 in late May. The central bank's last monetary policy statement has the TWI averaging 70.2 in the second quarter, falling to 68.6 in the final three months of the year.

Delays in the rebuild of Christchurch have caused economists to push back their predictions on when construction activity in the ruined city begins to use up capacity in the building industry. But there's no doubt the pressure are coming. Just last week the government put out a tender for 5 million litres of paint for the city, enough for 100,000 homes.

"Non-tradable inflation should pick up as post-earthquake rebuilding activity gathers momentum and begins to place capacity pressures on the economy beyond Christchurch," said Christina Leung, economist at ASB.

Data for wages and salaries in the second quarter isn't released by Statistics New Zealand until Aug. 7 with employment figures out on Aug. 9. Based on first quarter numbers, the labour market is showing little sign of overheating.

The unemployment rate rose to 6.7 percent, worse than the central bank had expected. The labour cost index rose 0.4 percent in the first quarter, less than the 0.5 percent market consensus.

"The eventual surge in home building activity directly related to reconstruction of Christchurch will only add to fundamental domestic inflation pressures - via construction and wage costs," BNZ's Ebert says.

BusinessDesk.co.nz

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