Economic Weekly: Inflation momentum slowly starting to build

This week brings the delayed release of Q4 CPI, one the first key pieces of NZ economic data in 2017. New Zealand’s inflation outlook has improved over recent months and we expect Thursday’s release to reflect this. We expect the CPI to register a 0.2% qoq increase, with annual inflation jumping to 1.1% (in line with the RBNZ’s forecast). While the quarterly lift remains soft, the sharp increase in the annual rate is driven in part by a particularly soft CPI result in Q4 2015 dropping out of the annual calculation. 

Domestic capacity pressures will continue to be a key driver of price increases. Construction-related prices have risen sharply over the past two quarters due to capacity constraints and we expect this trend to continue. In addition, capacity constraints are also beginning to bite in the services sector (notably the tourism industry), as evidenced by the lift in pricing intentions and selling prices in the Q4 QSBO results. Higher petrol prices in Q4 will also provide a positive boost to inflation. Further, the lift in petrol prices in Q4 looks to be followed up by a similar gain in Q1 2017, which will help support the upward momentum in inflation going forward.

However, the high NZD remains a key drag on tradable inflation and on a trade-weighted basis the NZD remains higher than the RBNZ’s forecast. The sharp drop in the net percent of merchants increasing prices in the Q4 QSBO is further evidence of the high NZD weighing on import prices. Food prices are also forecast to be a drag on inflation in Q4. Q4 tends to be a seasonally weak quarter for food prices (particularly fruit and vegetables) and, as a result, the RBNZ will look through any weakness from this source.

The RBNZ will undoubtedly be relieved to see inflation back within the 1 – 3% target band. However, with inflation only just within the band and recent NZD strength suggesting further downward pressure on tradable inflation to come, we don’t think the RBNZ will be counting its chickens just yet. As a result, we continue to expect the RBNZ to leave the OCR on hold for the foreseeable future and think market pricing of an OCR hike by the end of 2017 is getting ahead of itself.

While the Q4 CPI will be a key event domestically, US developments will continue to drive markets. One such development; Donald Trump is now the President of the United States of America and the new regime has officially begun. While his inauguration on Saturday morning (NZT) had limited impact on markets, uncertainty will remain elevated as we wait to see what Trump’s first moves as President are.