Stronger-than-expected inflation could spur a rethink at the RBNZ

Tuesday 16th October 2018

The Reserve Bank may have to rethink its rate cut option after higher-than-expected third quarter inflation pushed the annual number to just below the mid-point of its target range.

The consumers price index rose at an annual pace of 1.9 percent in the three months ended Sept. 30, Statistics New Zealand said. Economists expected an annual increase of 1.7 percent while the central bank had tipped an annual increase of 1.4 percent.

Stubbornly weak inflation has let the Reserve Bank keep the official cash rate at a record low 1.75 percent. Last month, governor Adrian Orr reiterated the next move could be down if the economy fails to fire. At the time, he noted higher fuel prices would affect near-term inflation and said he would "look through this volatility as appropriate" on the expectation of a gradual rise to the 2 percent target.

The New Zealand dollar jumped half a US cent on today's data and was recently trading at 65.76 US cents from 65.45 cents before the release.

Imre Speizer, Westpac Banking Corp's head of NZ strategy, said the kiwi may extend that gain.

Higher petrol prices weren't the only element to drive up inflation, with the non-tradables component - which focuses on domestic goods and services - also higher, he said.

"The market is saying they are not going to look through it," he said.

Jarrod Kerr, chief economist for Kiwibank, said the Reserve Bank can claim the growing inflation is due to global oil prices, a weaker currency, and government interventions but will probably have to raise the OCR earlier than forecast.

"The RBNZ is starting to be backed into an awkward position, with its view that inflation will gradually rise to the target mid-point increasingly untenable," Kerr said

"We believe that ultimately the RBNZ will be forced to begin gradually hiking the OCR sooner than is currently signalled. We believe the RBNZ will be able to hike by May 2020, six months ahead of their schedule."

Michael Gordon, a senior economist at Westpac, said the lift in non-tradable prices surprised to the upside for a second quarter and was stronger than the RBNZ expected.

"This makes the prospect of interest rate cuts a more difficult prospect for the RBNZ," he said.

Vicky Hyde-Smith, head of NZ fixed income for AMP Capital Investors, agreed the non-tradable inflation was marginally stronger and above RBNZ’s own forecast, although there was enough uncertainty for the Reserve Bank to remain cautious.

While the CPI data at best "reduces the probability of a cut near term," the RBNZ will want to see core measures of inflation moving higher to respond, she said.

"We will monitor the potential for this to impact inflation expectations, but have not changed our view on fixed income as a result," she said.

ANZ Bank New Zealand economist Miles Workman doesn't expect the central bank to back away from the rate cut option.

"We think the RBNZ will be quick to look beyond Q3’s print towards the medium-term direction for economic activity and core inflation. And in that regard, patchy data-flow and global developments suggest economic activity may struggle to keep inflationary pressures elevated," said Workman.

"While today’s solid inflation print presents something of a communications challenge for the RBNZ, we doubt it would do much to delay an OCR cut should the bank deem the growth outlook to be deteriorating," he said.

The central bank's next monetary policy statement will be published on Nov. 8. Investors will be keen to see whether it keeps the phrase: "the direction of our next OCR move could be up or down".

(BusinessDesk)

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