New Zealand inflation still low: Downside surprises continue

New Zealand inflation still low: Downside surprises continue

New Zealand Q3 CPI came in lower than expected, the annual rate falling from 1.6% to 1.0% (market expected 1.2%) – at the bottom of the RBNZ’s target band and below their forecast for +1.3%. The major slowdown in price pressures came in tradable inflation, which fell from +0.1% yoy to -1.0% yoy. In particular, mild weather limited the usual seasonal increase in fruit and vegetable prices. Over the past year, modest price pressures have emerged in the housing group but most other components of the CPI remain very subdued. Today's result suggests that there is a risk that rates remain on hold for longer than we had been expecting.

Facts

-CPI inflation rose by +0.3% q-o-q in Q3, below market expectations of +0.5%. The annual rate of inflation fell to +1.0% (market expected +1.2%, RBNZ +1.3%), the lowest rate since Q2 2013.

-Non-tradables inflation edged lower from +2.7% y-o-y to +2.5%. The major driver of non-tradable inflation over the last year has been housing and household utilities (up +3.4% y-o-y).

-Tradables inflation fell from +0.1% y-o-y to -1.0%. Falling prices for grocery food and new vehicles have been the major driver, with a smaller than usual increase in fruit and vegetables also seen in Q3.

Implications

New Zealand inflation continues to undershoot expectations. The economy has been growing strongly for some time now and yet price pressures remain surprisingly well contained.

There are a number of factors at play in keeping overall inflation subdued. New Zealand consumers emerged from the financial crisis with a much-changed attitude to debt and spending, which has seen retailers compete fiercely for business. That has seen a large degree of discounting, particularly for major purchases such as furniture. The discounting trend remains very much in force, with a greater degree of discounting recorded for household appliances and furniture in Q3.

It is likely that higher interest rates and a slowing housing market have also played a part in more restrained consumer spending, particularly with regard to durable goods purchases. And even in some areas where spending has been very strong – such as vehicle sales - the strong NZD has kept the prices of imported goods down. In fact, the annual rate of tradable inflation has been negative in nine of the last ten quarters.

Despite strong employment growth, the labour market has also retained a fair degree of spare capacity thanks to higher participation and strong inwards net migration. That has kept wage growth very subdued, restricting consumer purchasing power and creating little in the way of wage cost pressures for firms.

Near-term indicators do not point to any imminent surge in pricing pressures, but we do expect inflation to rise over coming quarters as above-trend growth continues, the labour market continues to tighten (albeit fairly gradually) and, in a major shift, the lower NZD exerts upward pressure on tradable inflation. That should prompt the RBNZ into further rate hikes in 2015, although the risk is that the OCR remains on hold for longer than the current Q1 2015 hike we had pencilled in.

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