J.P Morgan Report

J.P Morgan Report

·         Headline inflation printed higher than expected

·         One-off factors inflated headline CPI in 3Q

·         Non-tradable inflation will continue to head south

Inflation in New Zealand remained in the bottom half of the RBNZ’s 1-3%oya target range in the third quarter. The headline, at 1.7%, was higher than expected, but this owed largely to one-off influences that pushed prices higher. The non-tradable measure—inflation generated domestically and not influenced by the exchange rate—remained elevated but, as the chart below shows, has come down significantly in recent quarters and should meander even lower going forward; this reaffirms our view that the RBNZ’s tightening cycle is some way off, even though financial markets do not believe Governor Bollard is committed to maintaining the OCR “at or below current levels until late 2010.”

Consumer prices grew 1.3%q/q (J.P.Morgan and consensus 0.8%), or 1.7%oya, the lowest annual increase in over five years. Smaller annual increases in petrol prices, thanks to the stronger NZ dollar, were offset by higher prices for food, electricity, and local authority rates. The 5.4%oya rise in food prices accounted for well over half of the CPI annual increase, according to Statistics New Zealand. There were a few one-off influences on headline CPI. Vehicle re-licensing fees rose 16.2%oya, owing to an increase in the ACC levy, and alcoholic beverages rose 2.5%, owing to a higher excise duty from July. We still believe that 1.7%oya was the low-point for inflation in this cycle, but acknowledge that one-off factors pushed headline CPI higher in 3Q.

Non-tradable inflation at 3%oya remained at the very top of the RBNZ’s comfort zone, owing to significant upward contributions from electricity and local authority rates, which rose 4.5%oya and 6.6%, respectively. This is the first time, though, that non-tradable inflation has been within (just) the Bank’s target since early 2002. Thanks to the elevated NZD, the tradables component fell 0.1%oya in 3Q, the first fall in two years.

Although financial markets do not believe Governor Bollard is committed to maintaining the OCR “at or below current levels until late 2010,” we believe it will take a significant upside surprise in economic data to prompt an earlier move. The RBNZ also will have found comfort in that inflation expectations remained contained, with stronger activity yet to translate into expectations of higher prices. Inflation expectations have eased sharply since 2H08—the RBNZ’s own inflation measures, which are at 1.8%oya one year out, are their lowest since 1999.

We believe the OCR already has bottomed at 2.5% in the current easing cycle, with the next move to be a rate hike in mid-2010. We acknowledge the risk of an earlier rate hike, particularly if the non-tradable inflation profile is higher than we currently forecast. That said, though the domestic data recently has printed on the upside of expectations, the New Zealand economy is still fragile, having just endured its longest recession on record, which means there certainly still is a lot of slack in the economy. Further, there are numerous reasons to be cautious regarding New Zealand’s recovery path given question marks over the sustainability of the recent pickup in housing market activity. The recent rise in house prices can be largely attributed to a small number of listings, and the resulting mismatch between listings and demand. Indeed, the pick up in housing market activity has buoyed consumer confidence and spending, but rising unemployment and softer wage growth will curb the upside in 2010.

We forecast the RBNZ will shift to a neutral policy stance in December or in early 2010, paving the way for the first hike to be delivered in July. The first OCR hike will be a 50bp move. A larger move, though, can not be ruled out, but as long as the household sector continues to move toward shorter-term borrowing, a 50bp hike to kick off the next tightening cycle will suffice.
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