A Long Time Coming. Inflation Is Back Within The Band

• Last week was cause for many-a-celebration. Team NZ completed a historic 3-peat win of the America’s Cup. The Silver Ferns had a smashing start to the Constellation Cup. Auckland FC beat Brisbane Roar. And, of course, inflation is finally back within the band. The RBNZ’s 2% target is well within reach.
• Tradables is the reason inflation has returned to 2%. And the eventual normalisation in domestic price pressures is why we see 2% sustained in the medium-term. It’s the two phases of 2%. Phase 1, imported. Phase 2, domestic.
• Our chart of the week shows how the cost of living crisis is coming to end. For three years, real incomes have been eroded as inflation ran rampant. We’re now seeing the reverse.

Here’s our take on current events

It’s been a long time coming, but inflation is now back below 3% - more than three years to be exact. At 2.2%, the midpoint of the RBNZ’s 1-3% target band is well within reach. And the cost-of-living crisis is coming to an end (see the COTW below).

Over the September quarter, fewer items in the CPI basket recorded an increase in price (from 56% to 53%) while more items either recorded no change in price (from 12% to 14%) or declined in price (from 32.7% to 33.4%). And compared to a year ago, a far larger proportion of the basket recorded price declines – from 29% to 33.%. The shift points to generalised cooling in inflation pressures.

Even better news is the continued correction in core inflation. Stripping out volatile food and energy prices, underlying price pressures lifted 1%. Annually, core inflation is now just skimming the top-end of the RBNZ’s 1-3% target band at 3.1%. It’s a very welcome move confirming the underlying trend for inflation is down. And even better – moving closer to being below 3% in the coming months.

The September update was a great report, but it wasn’t perfect. The blemishes in the report were the few items still recording chunky price increases. Council rates increased 12.2% in the quarter, accounting for over half of the overall 0.6% increase in consumer prices. Rents let off a bit of steam but still running at 4.5% - well above the pre-covid ~3% rates. Pharmaceutical products had a particularly expensive quarter, up 17%, following the reintroduction of the $5 prescription payment

Imported prices are falling, and are down -1.6% over the year. Tradables – imported inflation – has done most of the work in wrangling inflation back within the band. The eventual normalisation in domestic price pressures is why we see inflation sustained at 2% in the medium-term. Domestic inflation is a slow-moving beast. The good news is that it is now moving in the right direction. Non-tradables price growth has slowed from 5.4% to 4.9% on an annual basis, and is some distance from the 6.8% peak. It’s the first time since September 2021, domestic inflation is sitting below 5%. That said, domestic inflation is still sitting high above the long-term average (~3%).

There is lingering strength in homegrown inflation, but underlying domestic price pressures are clearly weakening. And we still have more deflationary pressure in the pipeline as the economy runs below its productive capacity.

The risk in the near-term is inflation undershooting 2%. The RBNZ has begun relaxing interest rate settings. But a cash rate of 4.75% is still restrictive. If domestic inflation normalises faster than expected, then we will likely see inflation falling into the lower-end of the RBNZ’s target band. And that opens the door to further large reductions in the cash rate.

The light at the end of the tunnel is burning brighter. Cost pressures are easing. Great news for businesses and households, and interest rate relief is coming thick and fast. Policy settings are still restrictive, but more interest rate cuts are coming. We expect another 50bp cut in Nov. Falling inflation, and falling interest rates will help household budgets, and business opex.

Chart of the Week: Cost of living crisis is coming to an end.

The cost-of-living crisis has dominated headlines and emerged with the cost of everyday essentials rising at a faster pace than household incomes. And for the last three years, that has been the case in New Zealand, with some households disproportionately impacted. Unfortunately, households on lower incomes are hardest hit. Food and fuel – both of which have seen the largest increases in price – make up a larger share of low-income household budgets. And these households typically don’t have much wriggle room.

But now, pay rises are running above inflation. The cost-of-living crisis is coming to an end, slowly. It may not feel like it yet, but inflation has eased, and will ease further. Falling interest rates and rising house prices in 2025 should also bring much needed relief to households. With interest rates headed south, we expect a turnaround in the housing market next year. The September REINZ market update showed early signs of strength. House prices rose 0.2% over the month, the first increase in four months. But there is still a long backlog to go through first. It’s not until next year that we expect any meaningful improvement. We forecast house prices to appreciate 5-7% in 2025.

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