The descent from Mount Inflation continues, slowly.


  • The December quarter inflation report is out Wednesday. We expect the pace of annual inflation slowed a smidge to 7.1%. In the quarter, consumer prices are likely to have risen 1.3%.
  • An un-seasonal lift in food prices and elevated housing inflation is expected to be at the helm of the rise in consumer prices. Cost pressures continue to feed through to retail prices. But the recent decline in petrol prices should provide some offset and see imported inflation fall back. 
  • The RBNZ forecast inflation to rise to 7.5%. Should the official figure come in line with our forecast (7.1%), we may see a softening in the RBNZ’s approach, as downside risks grow. For the Feb meeting, the RBNZ have signalled a 75bp hike to 5%. We believe current conditions only warrant a 25bp move. So let’s meet in the middle.  If inflation prints as we expect, we’d expect the RBNZ to deliver 50bps (not 75), a move that should garner support from market traders.

The December quarter CPI report is out Wednesday. We expect the pace of annual inflation slowed a smidge to 7.1% from 7.2%. In the quarter alone, we expect consumer prices jumped 1.3%. While the latest report is expected to show a continued slowing in inflation, broad-based inflation pressures remain. All major groups bar one in the CPI basket are expected to print a rise in prices. 

The December quarter typically sees a decline in food prices as the price of fruits and vegetables cheapen. However according to Stats NZ, food prices lifted 1.8% in the quarter. The 5.2% seasonal drop in fruit and vegetables was offset by the chunky increases in other food items. Meat prices, in particular, were up 4% in the quarter. That’s one pricey summer BBQ. On an annual basis, food prices have risen to a 32-year high! 

We also expect to see elevated housing-related inflation. According to Stats NZ’s rental price index, rents jumped around 0.8%.  That’s a decent jump, however a smaller rise compared to previous quarters. Also underpinning the recent lift in housing inflation has been the rise in construction costs. There’s no denying the serious capacity constraints that the construction sector continues to face. However, we may be past the peak. The supply disruptions that have dogged the sector for the past two years are easing with shipping costs falling. And with a housing market clearly in retreat, demand should be cooling. Overall, we expect the housing group to post above a 1.9%qoq rise, adding above 0.6%pts to headline. The quarterly rise is slightly softer than previous outturns but a decent jump, nonetheless. As one of the main drivers of domestic inflation, another solid rise in housing sees annual non-tradables inflation remain elevated at 6.5%. 

Several surveys show that firms continue to face rising costs. According to NZIER’s latest QSBO survey, a net 80% of firms experienced rising costs in the quarter. And these cost pressures continue to feed through to retail prices. The Q4 survey also revealed over half of retailers reported to have increased their prices over the last three months. The December quarter is expected to see a lift in prices for imported consumer goods including clothing and footwear, as well as household contents and furnishings. Although the typical holiday sales may have tempered how high retailers lifted their prices. 

It’s not all one-way though. The transport group is expected to post a decline in prices, led by the fall in petrol. Global growth fears have intensified in recent month, and it’s weighing on commodity prices. Global oil prices, in particular, have tumbled to below USD$80/barrel. And local petrol prices have reflected the drop. We expect prices fell around 10%. The other important piece to the transport group puzzle however is airfares. And the higher cost of air travel – both domestic and international – have been well documented. The rise in airfares should provide some offset to falling petrol prices. Overall, the transport group is expected to have fallen 0.5% in the quarter, taking away about 0.06%pts from the headline print. The fall will see annual tradables inflation fall below 8%.  

A slow descent 

Inflation is forecast to descend from the current rates of above 7% towards 3% by the end of 2023. The journey back to the RBNZ’s 1-3% target band will be slow. For one, we must account for the expected end to the temporary Govt policy to tackle the cost-of-living crisis. The discounted fuel excise tax and half-price public transport fares will end later this month. The lift in public transport fares will unlikely have much impact on inflation given it’s relatively small weighting in the CPI basket. However, petrol alone has a weighting of 3.57%. Adding on a few more cents to petrol prices will surely make a difference to the headline inflation rate in the first quarter of 2023.  

CPIpreview_Q422_tradables_nontradables.pngThe focus is shifting away from imported inflation to domestically generated inflation. Imported, or tradables, inflation is likely to fall this year. That’s good news. Half of the inflation that we are experiencing right now, came from offshore. And global commodity prices have eased and shipping costs have fallen. The risk of recession in large parts of the world is also weighing on inflation expectations (it’s self-fulfilling). Domestically generated inflation, however, remains heated. And that’s the focus of the RBNZ. It’s domestic price pressures that they can influence. Although downside risks are growing. Wage inflation, a major component of domestic inflation, is expected to peak soon. Labour market conditions should loosen in the second half of this year, with the unemployment rate steady rising. Wage growth will naturally lose steam. We expect non-tradables inflation will peak around current levels of 6.5%, but a sticky descent follows. 

All up, we see inflation sitting slightly above the top end of the RBNZ’s 1-3% target band by the end of this year. And early next year should see inflation back within the band and on its way to the 2% target midpoint. It’s a slow journey back, but the descent has begun. 

We are just one month away from the RBNZ’s next decision. They have signalled another 75bp hike to 5%, from 4.25%. We believe current conditions only warrant a 25bp move. So let’s meet in the middle with 50bp. Should next week’s inflation print come in line with our forecast, we see the RBNZ delivering a 50bps hike in February – a move that should garner support from market traders. A lesser move has implications for the terminal cash rate. Currently, the terminal rate sits at 5.5% - with a 75bps hike baked in for February. A downshift to a 50bps move in February would also pull down the terminal cash rate. By the April meeting, the cash rate may peak at 5.25% or even lower at 5%.  We believe the RBNZ has gained enough traction with their rate hikes to date, and a terminal cash rate of 5% (or lower) is all that is required to meet the RBNZ’s mandates. We continue to highlight that a move to 5.5% is likely to be a step or two too far. Mortgage rates have nearly tripled. And both the NZIER business survey and REINZ housing statistics give cause for caution.

Should we see an upside surprise in next week’s inflation data – a familiar phenomenon in today’s economic environment – it will likely cement the 75bps increase implied in the RBNZ’s OCR track published in November.

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