Wages and currency shifts make inflation forecasting more difficult

 

17 July 2017

The local financial markets are not expecting anything too different for the June quarter’s CPI inflation result tomorrow to what the consensus forecasts are at +0.20/+0.30%. Basically, significant increases in food prices over recent months should be cancelled out by reductions in fuel prices due to lower crude oil prices and a generally higher NZD/USD exchange rate. Going forward, the debate about inflation trends will still focus on whether wages will ever increase and whether the well above average capacity utilisation in the NZ economy will also feed into bottlenecks and thus inflation. A combination of the pay equity adjustment in the public sector and shortages of skilled workers across multiple industries must certainly lead to upward wages pressures. We have yet to see these pressures reflected in official wages statistics. However, anecdotal evidence across our client base suggests that major catch-ups on very low wage increases over recent years are very much on the cards. The RBNZ do seem a bit complacent about this wages related inflation risk, however the trends over recent years do not evidence any sudden emergence of wage pressures. Recent tightening up of immigration regulations for work and student visas also points to even more shortages of qualified labour sources across our key industries (particularly hospitality, tourism and transport).

Whilst higher wages (thus eventual inflation) and a cooling in the Auckland housing market favour the moneymarket’s pricing of a first OCR increase in mid-2018, the RBNZ’s 2019 timing is supported by the higher TWI currency value. The TWI is currently above 78.00 and if it was to stay at this highpoint for another six months or so, the current RBNZ forecast of the annual inflation rate reducing to 1.00% by March 2001 may be too high as the REBNZ are assuming a 76.00 TWI. The exchange rate plays a pivotal role in inflation and GDP growth outcomes in New Zealand and the current TWI levels points to a risk of annual inflation being below 1.00% by March 2018. Therefore, the RBNZ should be sending a signal in their 10 August Monetary Policy Statement that monetary conditions (exchange rate and interest rates) are too tight as they are causing the annual inflation rate to move below the 1.00% minimum. Certainly well below the 2.00% inflation band mid-point that RBNZ target.

However, I suspect Trump trade tariff changes and political risk in New Zealand will send the NZ  dollar lower over coming weeks/months and will save the RBNZ from having to adjust their already dovish inflation forecast even lower.  

 

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