Economic Weekly: Focus turns to inflation

The NZ economy has performed well throughout the COVID-19 pandemic, particularly compared to most of its international peers.  But the economic bounce back has not been evenly shared across NZ, as highlighted by Nat Keall in our most recent Regional Scoreboard, released today.  The North-South divide has widened further over Q1 2021, as the South Island appears to have taken the brunt of the impact of international border closures. Tourism hubs like Queenstown continue to face significant challenges, with employment numbers down 5.2% from the beginning of last year. In fact, in Q1 this year Otago was below the national average on every other metric we measure, posting a huge 27% fall in construction.  Rural regions generally outperformed the major urban centres on the Scoreboard, with the resilience of the country’s primary sector helping support the broader New Zealand economy through the pandemic.

With NZ’s economic recovery well established, and the global economic recovery now firing, focus is now shifting to the rapid lift in costs and inflationary pressure.  The recovery in demand in NZ over the past 6 months has come at a time when resource constraints are becoming more acute.  In NZ, we are predicting annual CPI inflation to lift sharply from the second quarter of 2021, to reach 3.2% by the end of this year.  This week’s NZIER Quarterly Survey of Business Opinion (6th July) will provide an indication of how much of the rise in cost pressures is being passed onto consumers, with further confirmation to come in the following week’s Q2 CPI release (16th July).

Central banks have become more wary of leaving monetary settings too stimulatory in an environment of improving demand and a quickly building on inflationary pressures.  The RBNZ adopted an explicit tightening bias in May, with a number of US Federal Reserve officials recently noting that the time to normalise interest rates may be sooner than previously indicated.  This week the focus shifts to the Reserve Bank of Australia.   At Tuesday’s board meeting the RBA will provide an update on its yield curve control and the bond buying program.  Despite the current COVID-19 outbreak in Sydney, our colleagues at CBA expect the RBA to start tapering the pace of bond purchases from September, either via scaling back the amounts being purchased or spreading out the purchases over a longer period of time. The RBA may also use the opportunity to move to a more flexible programme.  CBA recently updated its Australian interest rate view, and now expect the RBA to start lifting the 0.1% cash rate in November 2022.  Nevertheless, we still expect the RBNZ to be towards the front of the rate hike queue, starting with a 25bp hike in the OCR in May next year or possibly sooner if the economy continues to perform well  jane.turner@asb.co.nz