The Reserve Bank of New Zealand (RBNZ) left the Official Cash Rate (OCR) unchanged at 5.50% last week, the highest since 2008 and where it has been since the last increase in May 2023.
It’s forecast track suggests there will be no respite for borrowers until next year, even though the economy is slowing more than expected, unemployment is rising more quickly and inflation has fallen to the lowest level in three years.
The headline consumer price index (CPI) increased at an annual rate of four per cent in the 12 months to the end of March, and the RBNZ expects it to end the year at 2.9 per cent, just inside its target band of 1-3 per cent.
However, this encouraging outlook is tempered by the fact that most of the decline has been driven by falling international (or tradables) prices.
In contrast, domestic or non-tradables inflation as the RBNZ calls it, is still far too high to provide any relief.
Tradables inflation is running at just 1.6 per cent annually, whereas non-tradables is still up at an uncomfortably high 5.8 per cent.
Non-tradables make up about 60 per cent of the CPI basket, and this is where the RBNZ needs to see evidence of weakness before taking its foot off the brake pedal.
This isn’t proving an easy task. The domestic economy is less competitive and prices for many goods or services are linked to the CPI due to indexation.
We’ve seen some progress on this front, but it’s been limited to segments that are typically more sensitive to tighter monetary policy, notably construction costs.
The cost of building a home hasn’t necessarily fallen, but the pace of increases in building costs have slowed dramatically as high interest rates bite.
We can’t say the same for rents (which have risen 4.7 per cent in the past year), rates (up 9.6 per cent) or insurance (up 14.0 per cent).
A higher OCR doesn’t always help slow price rises in these categories, which are all unavoidable costs for most people.
However, some would argue these are lagging rather than leading indicators, and that an element of catch-up pricing has been at play.
Inflation has also been high across the domestic services sector. This covers everything from healthcare and education to haircuts and hospitality.
Wages are the biggest cost in delivering all these services, and to slow the price rises we need to see the labour market ease and wage growth expectations moderate.
That’s why the labour market is such an important piece of the puzzle, and why it features so prominently in RBNZ commentaries these days.
The unemployment rate has risen to a three-year high of 4.3 per cent. That’s below the 25-year average of 4.9 per cent, but it’s much higher than the low of 3.2 per cent from 2022.
This has been making it easier for businesses to find staff without paying over the odds to pinch them from competitors.
Rising joblessness and falling job security aren’t good at all for affected households, but it’s light at the end of the tunnel from an interest rate perspective.
The most recent Quarterly Employment Survey saw average hourly earnings rise at an annual rate of 4.8 per cent, down sharply from the previous quarter and well below RBNZ projections.
That’s still too high to be consistent with low and stable inflation, but forward-looking indicators suggest wage growth will keep slowing.
In last months ANZ Business Outlook, firms’ best guess for wage settlements over the coming 12 months fell to 3.0 per cent, down from close to six two years ago.
When these more realistic expectations become entrenched in the minds of workers, price-setting behaviour from companies will follow.
There is a path to lower non-tradables inflation. It’s just a little longer than we hoped and there could be more than a few more bumps along the way.
While that should lead to lower interest rates, it won’t take all the pressure off.
Inflation measures the rate of change in prices, not the level of prices.
Lower inflation doesn’t mean lower prices.
If we get to two per cent like the RBNZ wants, all that means is prices would be rising by less.
Prices overall (as measured by the CPI) are 18.6 per cent higher than three years ago, and even if the inflation rate falls to zero tomorrow, we’ll still be stuck with that.
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Mark Lister
Investment Director
Market Insights enewsletter
Keep up to date with our fortnightly Market Insights enewsletter. Our research team provide timely and regular commentary and analysis on market developments, understanding investment jargon, and the impact of current events.