How low can you go?

Low inflation has already seen the RBNZ cut the Official Cash Rate to a record low. Now, although inflation is likely past its nadir, it’s only set to climb at a gradual pace – likely too gradual for the RBNZ’s liking. The RBNZ has essentially told financial markets that the OCR will be cut at the time of the August Monetary Policy Statement. We expect that they’ll cut rates again towards the end of the year.

The RBNZ will next review the OCR on 11 August. Much of the mystery around this decision has already been removed following an unscheduled economic update just over two weeks ago. That terse statement highlighted the RBNZ’s clear discomfort with the lingering strength in the NZ dollar, which is currently around 6% higher than they had been expecting. That’s a fairly sizeable surprise, and leaves the central bank fighting an uphill battle to achieve its inflation goals.

Inflation has now been below the bottom of the RBNZ’s target band for two years. In part, this has been due to temporary factors that have dampened prices, including earlier weakness in international oil prices. Inflation is set to rise back into the RBNZ’s target band over the coming year as those temporary downside influences pass. However, beyond this, the expected pick-up in inflation is looking like it will be fairly gradual.

The key reason for the lingering softness in inflation is ongoing weakness in tradables prices. The prices of imported goods remain subdued, while price competition in the retail sector remains intense. Combining these conditions with a NZ dollar that’s continuing to defy gravity, and we’re likely to see declines in tradable prices for some time yet.

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