The cat is out of the bag

Last week we finally witnessed the 16-year low in inflation we had been awaiting for some time. Annual inflation fell to just 0.1% in the March 2015 quarter – slightly softer than we or the market expected, though it was a touch higher than the Reserve Bank’s forecast of zero inflation.

As expected, the steep fall in fuel prices accounted for most of the decline in the annual inflation rate. But even aside from fuel, the picture remained one of subdued inflation across a wide range of sectors. Tradable goods and services prices, excluding fuel, were down 0.9% on a year ago due to the still-high New Zealand dollar and low global inflation. Import-heavy categories such as clothing (-1.2%), household contents (-1.3%), recreational goods (-1.1%) and vehicles (-1.5%) have been falling in price for some time, and continued to do so in the latest data.

Meanwhile, annual non-tradables inflation slowed to 2.3%, compared to 3.0% a year ago.

The one exception to this soft inflation picture is housing-related prices. Prices for new homes excluding land were up 5% on a year ago (although that’s down from 5.4% last quarter). There was also a notable acceleration in Auckland rents from 2.2% to a 2.6% rate of annual increase. However, annual rental growth in Canterbury slowed from 4.9% to 4.2%, reflecting the gradual restoration of the region’s housing stock.

But housing-related inflation is becoming an increasingly isolated exception to the general theme of low inflation. The Reserve Bank’s sectoral factor model, which strips out volatile items in an attempt to estimate the underlying trend in inflation, is now showing a downtrend in underlying inflation and sits at just 1.3%. Wage growth and pricing intentions are subdued despite the strong economy. And surveys of inflation expectations have fallen hard.