February 04, 2024

Inflation decreasing – a false horizon?

Complex international factors may yet result in further increases in inflation

Recent economic developments may mean New Zealand is not out of the deep waters of inflation yet.

The latest Consumer Price Index (CPI) data, courtesy of Statistics New Zealand, conveys a promising decrease in the annual rate of inflation (disinflation), from 7.2 percent in December 2022, to 4.7 percent in December 2023. This is the lowest annual inflation rate in two years and is a promising stabilisation of prices, bringing relief to households and businesses alike. 

Primarily, disinflation has been driven by a decrease in the price of tradeable goods and services in the economy. Tradeable goods, such as food and fuel, are easily moved and sold across international borders. As the international economy recovers from the lingering effects of the pandemic, and the domestic economy recovers from recent natural disasters, there is an expectation that tradeable prices will stabilise. This is highlighted by the quarterly inflation rate of tradeables being -0.2 percent in December 2023, indicating a steadying of the supply chain of everyday products and services. As an example, the food group tradeables, had a quarterly change of -1.2 percent, indicating a fall in prices.

It is non-tradeable inflation that is consistently above the Reserve Bank’s (RBNZ) target inflation rate of between 1 and 3 percent. Annual non-tradeable inflation was 5.9 percent. This may be caused by lingering effects from the increase in money supply to combat the impacts of the pandemic, or improved business confidence in the new government, driving demand. 

Source: Statistics New Zealand

With inflation seemingly under control, does this mean the RBNZ will lower the official cash rate (OCR)? The regulator is facing a complex set of factors that reduce the likelihood of OCR decreases. 

Despite headlines to the contrary, housing prices may not be stable yet

Housing and household utilities only increased in price by 0.8 percent in the final quarter of 2023, suggesting housing is currently not a massive contributor to current inflation. However, the new government’s housing-investment friendly policies are likely to incentivise demand in the housing market, leading to price increases.   

Even if the RBNZ was not worried about housing inflation, the record net migration may make it hesitate to drop the OCR too soon. Net migration reached a record 128,900 people in 2023, each of whom requires shelter, food, clothing and all the other essentials of life. Businesses will see increased demand for their goods and services, increasing prices and causing demand-driven inflation. In at least one major category, housing, supply continues to be outpaced by demand. Therefore, it can be expected that there will be demand-driven inflation into 2024. 

Switching back to government policy, a set of proposed tax cuts may also increase inflation by increasing demand. When compounded with the net migration, if these tax cuts are implemented, it is hard to assume they would not cause an inflationary effect on the economy.

Transport costs is one area where the future appears increasingly bleak

Current instability in the Middle East threatens oil supply, despite our reliance on third parties to provide refined fuel products. If crude oil inputs for oil refiners increase in value, the price for refined oil will follow suit, quickly eliminating any price stability. Furthermore, the recent attacks on shipping were not recorded nor significant enough at the time to impact inflation figures.

It is not only oil prices that may increase. As New Zealand is largely dependent on imported goods, any increase in shipping prices will be felt directly by consumers. Shipping freight transport costs have already increased by 170 percent to Europe. This signified the huge increase in freight rates in January 2024, and if freight prices remain elevated, this will flow through to price increases in the March quarter. 

Ships skipping the Suez channel take 14 days longer on average to reach Europe, effectively decreasing the supply of container ships. What this means is that less profitable shipping routes, such as those to New Zealand, have freight vessels relocated to other routes. The decreased supply of shipping capacity increases the price of freight on the remaining vessels. 

The inflation figures are promising, but RBNZ may be hesitant to reduce the OCR in the face of a challenging inflationary future.