Past the worst

Last week, we received updates on the Consumer Price Index and dairy prices – two factors that have an important bearing on the outlook for the New Zealand economy and the future path of interest rates. Annual CPI inflation softened in the September quarter, but should rise gradually from here.
Nonetheless, it will be a slow return to the Reserve Bank’s 2% target midpoint, and a November OCR cut looks likely. Meanwhile, we’ve revised our milk price forecast higher to $5.30, as wet weather dampens New Zealand milk production.

Consumer prices rose by 0.2% in the September quarter, resulting in annual inflation slowing to 0.2% from 0.4% in June. And while inflation has now eluded the Reserve Bank’s target band of 1% to 3% for two years, this doesn’t fundamentally change the picture for the Reserve Bank, as they had forecast a slowdown in September quarter inflation in the August Monetary Policy Statement.

The soft outturn in September reflected temporary factors such as a decline in fuel prices and the second of two large reductions in ACC levies. But just as inflation in September was held down by temporary factors, inflation should soon pick up as previous disinflationary factors drop out of the annual calculation. Indeed, our early calculations have annual inflation picking up to 1% in the December quarter. If this forecast came to fruition it would no doubt provide the Reserve Bank some relief that CPI inflation was finally back in the band.

However, this would only be the beginning of the road for the Reserve Bank, with the return to the 2% midpoint still shaping up as being uncomfortably slow. And inflation expectations, to the extent they are backward looking, could take a further hit from September’s soft result. This would make it that much harder to get inflation back to target. For those reasons, the Reserve Bank has more or less committed itself to a further OCR cut, most likely in November. Beyond that, the case for additional easing in 2017 looks less compelling, especially compared to a few months ago, given the range of data pointing to the continuation of solid growth. But a lot can change between now and next year, and the Reserve Bank will want to keep their options open.

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