Mark Lister, 30 April 2021

Inflation was in the spotlight last week, with the release of the latest consumers price index, or CPI. Measured quarterly, the CPI records the changes in the price of goods and services for New Zealand households.

Inflation influences mortgage interest rates and the New Zealand dollar, while it is also used to calculate changes to benefit payments. This makes it quite important for all of us, whether we’re homeowners, savers, investors or business owners.

The good news is that there isn’t really any inflation to speak of at the moment. The March quarter CPI rose a modest 0.8 per cent from the previous quarter and is tracking at an annual rate of just 1.5 per cent.

Under its current agreement with the Government, the Reserve Bank is required to keep the annual increase in CPI between one and three per cent, on average, over the medium term.

With inflation at the low end of that range, there is no pressure on the Reserve Bank to raise interest rates.

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The bad news is that inflation is almost certainly headed higher from here, so we should brace ourselves for price increases and rumblings about whether the Official Cash Rate needs to go up in response.

The Reserve Bank sees the headline CPI increasing to an annual rate of 2.5 per cent for the next two quarters, which would be the highest we’ve seen since 2011, a decade ago.

There are several moving parts to keep an eye on when considering the inflationary backdrop.

Higher commodity prices, shipping disruptions and supply chain blockages are having a major impact on the prices of imported goods at the moment.

A lack of migrant workers is also pushing up labour costs for some sectors, as have increases in the minimum wage and additional holiday entitlements.

While these issues are causing high readings of pricing intentions in business surveys, there is a good chance some of the pressure dissipates over the next 12 months.

Then again, recent housing policy changes will likely lead to higher rents and these will be more permanent in nature.

Rents represent just over 10 per cent of the CPI ‘basket’ used by Statistics NZ. The basket is based on how households spend their money, and it’s regularly updated.

LP records were included in the 1960s, but removed three decades later. Waterbeds, wine coolers and compact discs were all added in the 1980s but have since been removed. Vaping devices and exercise equipment were added during last year’s rebalance.

Just like any one size fits all solution, the basket isn’t perfect. Those on low incomes feel an above average burden from steady rises in essential costs like electricity and gas, local body rates, rent and insurance.

However, they don’t always get the offsetting benefit of falling prices for other goods and services, many of which are discretionary, and would be considered luxuries by many.

Looking out a little further, the Reserve Bank expects this looming inflationary spike to be short-lived. It believes many of the pandemic-related shortages and supply chain issues will pass, and inflation will fall back into a benign range of 1.5 to 1.7 per cent during 2022.

Others would disagree, believing post-COVID money printing policies will fuel an inflationary surge in the years ahead.

Maybe they’re right, although let’s not forget the US, Japan and Europe have all been engaging in such policies for years now, and there has been little threat of inflation.

In the US, the unemployment rate was 3.5 per cent at the beginning of 2020, the lowest in 50 years. There was still no sign of any persistent inflationary pressures, apart from asset price inflation, that is (but that’s another blog post).

I suspect technology advances over the past couple of decades have been more than enough to offset the cheap money.

Netflix and Disney+ have lowered entertainment costs, Amazon and Ebay have changed the face of retail, Uber has revolutionised the taxi industry and technology has made communication much cheaper, to name a few examples.

Globalisation has also had a massive impact, as the tariffs and subsidies of old have been removed and China and other low cost economies have factories to the world and dramatically reduced production costs.

These two long-term themes, as well as an aging world population, haven’t gone away and the disinflationary impact they might have shouldn’t be underestimated.

Inflation is almost certainly headed higher over the next six months, which won’t go unnoticed by policymakers and financial markets.

However, whether this proves to be a short-term phenomenon or a more persistent increase remains to be seen.