Business Price Inflation at 14 year high

For the March 2022 year, the rate of increase in the Producer Price Index (PPI) Inputs reached 9.8 percent, while the increase in PPI Outputs reached 8.8 percent. In comparison, the Consumers Price Index (CPI) was 6.9 percent for the March 2022 year. This means that both producers’ input prices and output prices increased by more than the overall price increases faced by consumers.     

Despite the rapid increase in input prices, as shown in the graph, output prices so far have increased by a slightly smaller amount. However, it is likely that output prices will continue to increase until shortly after input price growth starts to slow. This is because output price rises are a direct result of input price increases, and therefore will lag behind input price increases. 

While the Reserve Bank of New Zealand and New Zealand Treasury do not publish forecasts for business prices, they are currently forecasting strong consumer price inflation for the rest of 2022. Given that increasing PPI Output prices will lead to higher consumer prices, we can expect that business price inflation (both PPI Inputs and PPI Outputs) will continue to remain at around 10 percent for the remainder of 2022, contributing to the higher consumer inflation forecasts. 

Below the headline PPI Input and Output numbers, the increases varied across industries. For PPI Inputs, the three industries seeing the largest increases in the March 2022 year were Manufacturing (up 18.6 percent), Transport (up 12.6 percent), and Mining (up 12.5 percent). At the other end of the scale, industries that have seen the smallest changes in PPI Inputs in the March 2022 year were Electricity and gas (down 5.4 percent), Information and media (up 2.8 percent), and Finance and insurance (up 3.1 percent).

For PPI Outputs, the three industries seeing the largest increases in the March 2022 year were Mining (up 20.3 percent), Manufacturing (up 17.5 percent), and Agriculture, forestry and fishing (up 14.1 percent). At the other end of the scale, the industries that have seen the smallest changes in PPI Outputs in the March 2022 year were Electricity and gas (down 2.6 percent), Information and media (up 0.6 percent), and Finance and insurance (up 1.7 percent).

Overall, this shows that service based industries (Information and media, and Finance and insurance) have been the least affected by input and output price increases, while goods based industries (Manufacturing and Mining) have been the most affected.

Increases in PPI Input prices, which flow through to PPI Output prices, are being driven by both international and domestic forces.

The main international causes of the current high business price inflation are as follows:

1. Reduced global production, which has fallen due to the COVID-19 pandemic and has not yet returned to pre-COVID levels. A good example of this is in China, where the Government revealed in April 2022 that manufacturing production was at its lowest level in two years. This is backed by a key gauge of manufacturing activity, the Purchasing Managers Index. In April 2022, this index was at 47.4, below the 50 point mark which separates growth from contraction

2. Container shipping rates, which as of April 2022, are still around five times higher than the rates seen in March 2020, at the start of the pandemic. Statista, which tracks the freight costs for a 40 foot container on the eight largest freight routes, reports that in April 2022 freight costs for that size container were US$7,768, compared to US$1,525 in March 2020. These freight costs have been falling from the peak of US$10,361, hit in September 2021.  

3. The Russian-Ukrainian war, which has further disrupted global markets. Oil prices have been pushed up, as well as prices for grain, sunflower oil, and fertilizer, with a high proportion of global exports of these goods coming from either Russia or Ukraine. Oil price increases (the Brent Crude Oil price has risen from US$75 a barrel at the end of 2021 to around US$113 a barrel as of May 20 2022) have pushed up petrol prices in New Zealand to around $3 a litre. 

The main domestic causes of the current high business price inflation are:

1. Wage pressure within the New Zealand labour market, with the unemployment rate as of March 2022 sitting at just 3.2 percent. At the same time the Labour Cost Index (LCI) was up three percent for the year to March 2022. Both the Reserve Bank of New Zealand and NZ Treasury are forecasting the LCI to reach four percent in 2022. While these increases in labour costs are well below the increase in the Consumer Price Index across the same period, over the last 10 years annual increases in the LCI averaged just 1.9 percent. This means that New Zealand is seeing a notable increase in labour costs, compared to the annual increases seen in recent years. This is being driven by the severely limited New Zealand labour market (as mentioned, unemployment is down to slightly over three percent), combined with the severe restrictions on migrant workers due to New Zealand’s border closures. While these border restrictions have been lifted in 2022 for skilled workers, it will take some time for skilled migrant workers to be a part of the New Zealand workforce.

2. Higher prices for New Zealand exports, which, because of our reliance on export markets, mean that domestic prices at both the wholesale and retail level have increased. The best example of this is Fonterra, which uses the global dairy commodity price to determine the wholesale prices of its goods sold in New Zealand (due to around 95 percent of dairy production being exported) to businesses who use dairy inputs to create dairy products.   

Higher input prices in themselves will not affect business activity. As long as businesses are able to pass along the increase in input prices to their customers, they will maintain current business activity levels. This can be seen in the very similar movements between the PPI Inputs and PPI Outputs prices indexes, where output prices slightly lag input price movements. This is because businesses adjust output prices based on changes in their input prices.

But, as consumers start to face higher prices, it is inevitable that demand will start to fall, unless incomes rise as fast as the prices of goods and services. This is because, as prices rise, consumers will have less ability to purchase the same amount of goods and services as they did prior to the price rises. Therefore consumers will start to reduce their overall demand for goods and services.

In New Zealand’s case, while domestic demand will start to fall because of rising prices and increases in the OCR, exporting businesses may be helped to maintain business activity by more consistent international demand for their goods and services. 

The best example of how higher input prices are affecting business activity is currently the New Zealand construction sector, which is seeing rapidly increasing prices for building materials, as well as outright shortages for some building materials. These price increases and shortages will have a knock-on effect on the level of activity that can be sustained in the sector.

Overall, given that the causes of business price inflation will be here to stay across 2022, we can expect that business activity in the second half of 2022 will start to slow. This will be due to domestic demand slowing down as the combination of higher prices, and higher mortgage rates, reduce the quantity of goods and services New Zealand households are able to purchase.