Economic Weekly: COVID's impact on NZ's inflation surge

The Q3 Consumer Price Index, released this morning, revealing a stronger than expected lift in annual CPI inflation, to 4.9% - a full note covering the data will be released this morning. The key question going forward is how high will annual CPI inflation peak and how persistent will above-target inflation be.

There are multiple factors driving higher inflation pressure – much of the lift in inflation pressures over the past year has been internationally sourced (see chart opposite).  Recovering global economic demand has pulled commodity prices higher, while at the same time a supply shock from supply chain disruptions has contributed to cost-push inflation. There isn’t much the RBNZ can do about globally-sourced inflation pressure but monitor and react to the impact on NZ wage and price setting behaviours.  Already, inflation pressures have led to a lift in the RBNZ’s much watched 2-year-ahead inflation expectations measure above the 2% inflation target midpoint, to 2.3%.  This increase is likely a contributing factor to the RBNZ’s determination to unwind policy stimulus despite current COVID uncertainties.

Going forward over the next year, the key driver of inflation pressures was expected to shift towards domestic drivers, as the labour market was extraordinarily tight prior to the NZ Delta community outbreak (indeed domestically driven inflation lifted by much more than we expected in Q3).  However, going forward the labour market outlook is less clear. Since the August outbreak, the numbers on job seeker benefits have lifted, albeit a mere fraction of the lift seen in the March 2020 outbreak – which suggests firms are making a strong effort to hold onto staff.  However, the longer Alert level 3 restrictions drag on in Auckland, the slower and less complete the NZ economic recovery will be – and this will also be reflected in the labour market.  We believe the restrictions are likely having a disproportionate impact on small business owners.  Without further support to those locked out of their businesses for over 2 months, there is a concern that many of these small business owners can’t hang on much longer.  

Finally, we are potentially only months away from border restrictions being eased, possibly allowing more NZer’s to come home.   NZ could see a perfect storm of softening labour demand, but an increase in labour supply from early next year and if this was to happen it would relieve some of the domestic inflation risks for the RBNZ.  However, the key word here is if – there remains a significant degree of uncertainty over the next 3-6 months as the world continues to learn how to manage Delta.  

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