GDP and Inflation

Inflation weakens – OCR to stay low for longer

Thursday July 20, 2017 Mark Cox

At the beginning of this year it was widely expected that, having spent five years below the Reserve Bank’s 2% target rate, inflation would start to increase.  And, lo and behold, it did.  In the March 2017 quarter, the annual rate of increase in the CPI reached 2.2%.

 

However, the rate slipped back to just 1.7% in the June 2017 quarter.  Prices for alcohol and tobacco were 3.7% higher than a year earlier, prices for housing and utilities were 3.1% higher, prices for health-related goods and services were 2.8% higher, and prices for education-related goods and services were 2.2% higher.  Food prices were 2.0% higher, but prices for recreation and culture goods and services were 0.2% lower, and prices for communication-related goods and services were 4.6% lower. 

 

21 07 graph 02

 

The rate of inflation matters for a whole range of reasons.  Increasing inflation is harmful to individuals and households that are unable to increase their incomes.   Likewise, it can hurt households that have mortgages and other loans, if it induces the Reserve Bank to increase the OCR.   By contrast, individuals and households that have savings will benefit, if the OCR increases.

 

Businesses can benefit from increased inflation because it tends to boost cash flow, but it can also harm those that have debts.  Government finances tend to improve slightly overall when inflation is moderate.  This is because, although Government expenditure on indexed entitlements and benefits will increase, tax revenues will tend to increase faster.

 

So, where are the CPI and the OCR heading?

 

BERL believes that the rate of inflation will fall slightly from its current level and stay low for the foreseeable future.  BERL does not forecast the OCR, but believes that both the 90-day bank bill rate and the 10-year bond rate will fall slightly in the next year.  The consensus amongst the various bank economists is now that any increase in the OCR will be delayed from around the middle of 2018 until at least the end of that year.

Borrowers will, therefore, remain in a comfortable position, as long as they can maintain their incomes.