Mark Lister, 18 April 2019

Wednesday was a big day for the local financial markets, not to mention news agencies around the country.

First we had the March quarter inflation report, which was weaker than expected (at the headline level at least). Later in the day, we saw the highly anticipated response from the government to the final report of the Tax Working Group (TWG).

Both of these have important implications for business confidence, the economy, interest rates and the NZ dollar.

The first was the consumer price index (CPI) for the three months ended 31 March. It increased just 0.1 per cent for the quarter and 1.5 per cent on an annual basis, compared with market forecasts for 0.3 per cent and 1.7 per cent.

This was a soft result, the lowest in more than two years, and consequently we saw a strong reaction in the immediate aftermath. Interest rates declined and the NZ dollar fell sharply, slipping below US$0.67 for the first time in three months.

With the Reserve Bank of New Zealand (RBNZ) having opened the door to interest rate cuts last month, traders saw the lower inflation figures as a precursor to a move in the Official Cash Rate (OCR) as early as May.

However, the detail painted a slightly different picture. Virtually all of the weakness in the CPI was due to lower imported inflation, on the back of a stable currency, lower oil and petrol prices, and cheaper airfares.

Domestic indicators, on the other hand, were much stronger and pointed to underlying cost pressures in the economy. Non-tradables inflation rose 1.1 per cent for the quarter and was up 2.8 per cent on an annual basis.

The average person on the street might struggle to accept that the cost of living has only risen by 1.5 per cent in the past year, unless they happen to fly a lot.

Then came the big one. Prime Minister Jacinda Ardern announced that the government had dropped its intentions to impose a capital gains tax (CGT), because of the inability of the coalition to form a consensus.

She even went a step further, making a commitment that under her leadership no government would campaign again on a CGT, let alone implement one.

This was a bigger change in stance than expected, and financial markets took notice. The currency rebounded from its earlier falls and bets for a May OCR cut were pared back slightly.

Businesses might now be able to stop worrying about a CGT, with this risk firmly off the table regardless of who forms the next government. That should allow many businesses to refocus on their core operations, which should be supportive for near-term growth.

The sharemarket was only marginally higher on this news, having been relatively unaffected by the CGT debate in recent months. Nonetheless, the NZX 50 index is sitting at record highs, less than half a per cent away from reaching the milestone of 10,000 points.

If the business community responds well to the removal of the CGT threat and the RBNZ indeed chooses to respond to stubbornly low headline inflation, it’s probably a matter of time before we push through it.