New Zealand inflation strong

18 July 2011

Inflation surprised on the upside, running at +1.0% in Q2 and +5.3% over the year (market had +0.8% q-o-q and HSBC had +0.9% q-o-q). The rise in the quarter was mostly driven by tradables, particularly fuel, while the non-tradables component, which is a better guide to domestic inflationary pressures, was more modest. Nonetheless, across a range of indicators inflation now looks uncomfortably high, particularly for the beginning of an economic upswing. We remain of the view that the RBNZ will seek to reverse emergency settings this year, with Q4 our central case, though the risk is for an earlier move.

Facts
- Headline CPI rose by 1.0% in Q2, stronger than the 0.8% expected by consensus and HSBC's expectation for a 0.9% rise.
- Over the year, headline CPI inflation was 5.3%, ahead of consensus and HSBC at 5.2%.
- Tradables inflation ran at 1.5% in Q2 and 5.5% over the year (up from 3.7%), with a significant contribution from transport prices reflecting petrol and airfares.
- Non-tradables inflation eased to 0.6% in Q2, but continued to run at 5.2% over the year.
- Statistics New Zealand estimates suggest that even when they abstract from the effect of the GST increase last year, which boosted the CPI, headline inflation is still running at 3.3% over the year to Q2. This is still above the RBNZ's target zone of 1-3%.

Implications
The New Zealand economy is recovering from an extended period of economic malaise and today's CPI report suggests inflationary pressures are also building.

Across a range of metrics it looks as though inflation is now running at an uncomfortably high level.

To start with, headline inflation is 5.3% over the year, which is well above the RBNZ's target band of 1-3%. Of course we know that it has been boosted by the effect of tax changes last year, but Statistics New Zealand has told us that when they abstract from those changes, headline inflation is still running at 3.3%, which is above the target band.

Besides, the Q2 results, in and of themselves, are not affected by last October's GST increase, and headline inflation rose by 1.0% in Q2, which is well above the target band in annualised terms (4.1%). The argument, put by some, that the GST change may have had some effect on the Q1 numbers, as well as obviously impacting Q4 2010, does not really hold for Q2 2011.
Digging a little deeper, the non-tradables component of the CPI, which is a better reflection of domestic inflationary pressures, is running well above the target band y-o-y at 5.2%. Even on a quarterly basis the non-tradables component is sitting in the upper part of the target zone at 0.6% q-o-q (which is 2.4% annualised). Q2 is also a seasonally weak quarter for non-tradables inflation, so we'd typically expect a rise in Q3.

Tradables inflation is very strong, on the back of oil price rises earlier in the year, running at 1.5% q-o-q and 5.5% y-o-y. Of course, we expect pressure on tradables to ease in coming months as oil prices have come down and the NZ dollar has strengthened (up around 12% against the USD since its trough in mid-March).

Inflationary expectations have also been high recently, with two-year ahead surveyed expectations at the top of the RBNZ's target band, at 3%.

All in all, inflation is above, or in the upper part, of the target band on a large range of metrics. This is an awkward starting point for an upswing in an economy.

The key question will be, how convinced is the RBNZ that a strong upswing is now in train? On this, they may have some lingering concerns that some weakness from the Canterbury earthquake will still show up in the Q2 indicators. They will also be watching the world, particularly Europe, very carefully at moment, given New Zealand's large overseas funding requirement. These factors may keep them on hold for a bit longer, but with a recovery in swing and inflationary pressures building, we expect a reversal of emergency rate settings to be on the cards soon.

Bottom line
Inflation remains above the RBNZ's target zone.

We expect the RBNZ to reverse its emergency settings soon, with Q4 our central case, though the risk is for an earlier move.

Paul Bloxham, Chief Economist (Australia and New Zealand)
HSBC Global Research
Economics - Data Reactions
18 July 2011

ENDS

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