There's disinflation of goods, but with services-sector inflation not slowing, inflation could get stuck at high levels
The Reserve Bank’s fight with inflation is far from over, with ANZ economists warning that CPI inflation could get “stuck” above the RBNZ’s target band of 1-3% if service sector prices don’t slow down.
In an ANZ study titled ANZ Insight: Inflation Rotation, Sharon Zollner (pictured above), chief economist, said headline inflation appears to have peaked in New Zealand with the country mirroring the global trend of “inflation pulse rotating away from goods and towards sticky services prices.”
The ANZ economists said there was a “very welcome” global disinflation of goods, meaning New Zealand should be importing less inflationary pressure from overseas.
However, services inflation has continued to build, highlighting the risk that “even as the global inflation pulse starts to fade, domestically generated inflation and our super-tight labour market will keep the pressure on the RBNZ to remain tough on inflation.”
“Services prices are now contributing more than 2ppt to annual CPI inflation and are showing no signs of slowing,” Zollner said. “Should that continue, we could see CPI inflation get ‘stuck’ above the RBNZ’s 1-3% target band, even if goods inflation returns to historically average levels.
“Combine a sticky services inflation pulse, with the risk of stubbornly high goods inflation due to the cyclone or a renewed round of global goods inflation, and it’s worryingly easy to imagine overall CPI inflation remaining above the RBNZ’s 1-3% target range over the next few years.”
With the inflation pulse shifting towards services, ANZ expects the feedback loop between a tight labour market and rising services inflation to be a key determinant of how high RBNZ, and its international counterparts, will lift interest rates, and when and if they will reduce them over the next few years.
New Zealand is clearly not out of the inflation woods yet, but the ANZ economists said the relentless upside surprises of 2021 and 2022 are hopefully over.
“But it’s a long journey from 7.2% inflation back to the 2% midpoint of the RBNZ’s target band,” Zollner said. “And there are already significant bumps in that road. All of this points to the risk that interest rates will remain high for longer than markets currently anticipate. We therefore continue to expect the RBNZ will hike the OCR to a peak of 5.25% by May 2023, before holding rates at this level until at least the end of 2024.”
The ANZ report noted that there are plausible scenarios in which the OCR ends up significantly higher or lower than the bank’s baseline forecast.
“However, with global economic momentum picking up again in early 2023, the labour market still beyond maximum sustainable employment, and Cyclone Gabrielle posing further upside risk to domestic inflation pressures, it’s fair to say that we see the risks being tilted firmly towards the OCR being lifted higher than our current expectation of a 5.25% peak,” Zollner said.
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