Why lower inflation doesn’t mean lower prices

New Zealand’s inflation rate picked up in the June quarter, with the headline consumer price index (CPI) rising at an annual rate of 2.7 per cent.

That’s the highest in a year, and it was slightly above Reserve Bank of New Zealand (RBNZ) forecasts.

The RBNZ won’t be too bothered by this, as it would’ve expected a slightly hotter print given the newsflow since finalising these forecasts in May.

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While the inflation rate is nearing the top of the RBNZ’s target band of 1-3 per cent, at least it’s still the two’s.

The 2.7 per cent print for June was also a little lower than economists had been expecting.

That’s why we saw the odds of an Official Cash Rate (OCR) cut in August increase after these figures came out.

The RBNZ is tasked with keeping it near the two per cent midpoint of its range over the medium term.

That means it’s more concerned with how inflation is developing looking ahead 12 months or more, than over the coming quarter.

In that regard, while it sees pricing pressures intensifying over the next few months, it believes the headline inflation rate will average very close to two per cent through 2026.

Part of that confidence is due to the spare capacity across the economy.

Unemployment has been trending higher, and that labour market slack is likely to keep a lid on pricing pressures.

This makes an OCR cut later this month quite likely, which would take it to 3.00 per cent.

There could be more to come after that too, depending how the rest of the year plays out.

It’s not all good news though, and even if we can declare inflation beaten the effects of the cost-of-living crisis still linger.

This is what matters most for New Zealand households, and there’s an important distinction we need to make when talking about inflation and the cost of living.

Inflation measures the rate of change in prices, not the level of prices.

Lower inflation doesn’t mean lower prices.

Even though inflation is comfortably back in the RBNZ’s target zone of 1-3 per cent, prices are still going up.

They’re rising at a slower pace than they were a couple of years ago, but they’re still rising.

The CPI basket overall is 25 per cent above where it was five years ago.

Depending on how your household lives, you might be facing cost increases even higher than that.

A few things have fallen in price over that period, including telecommunications, AV and computer equipment.

These categories are all genuinely cheaper today.

Furniture, clothing, vehicles and household appliances have risen only modestly, so after adjusting for wage growth these could be considered more affordable too.

The labour cost index, which is a good indicator of overall wage growth in New Zealand, is up about 17 per cent over the past five years.

That’s the strongest rise since the 1990s, but it hasn’t kept up with inflation.

Another important point is that many of the things that have become more affordable are nice to haves.

In contrast, some of the unavoidable essentials have risen much more sharply.

Insurance and property rates have soared 35 and 45 per cent respectively, while the transport and food groups are up 27-28 per cent.

The thing with inflation is that its effects are cumulative and they compound over time.

Once prices rise, they rarely fall back.

The pace of the increases may have slowed right now, but we’re stuck with the big rises of the last few years.

Even with the economy turning a corner and better times ahead, those higher baseline prices are set to remain a headwind for some time yet.

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