Annual inflation, as measured by the consumer price index (CPI), increased to 3.3 percent in June 2021.
This was the biggest increase in nearly ten years and was driven by higher prices for new housing and petrol. Quarterly inflation was 1.3 percent, also the highest in over a decade.
The 3.3 percent inflation rate exceeds the Reserve Bank of New Zealand’s medium term policy target.
While increased inflation was expected, given historically low interest rates and increased government spending, this was greater than many economists predicted. The 3.3 percent inflation rate exceeds the Reserve Bank of New Zealand (RBNZ) Policy Targets Agreement, to keep future CPI inflation outcomes between one percent and three percent on average over the medium term.
As the graph shows, annual inflation had previously peaked at 5.3 percent in June 2011, however this included a Goods and Services Tax (GST) increase of 2.5 percentage points that came into effect in October 2010. Before this, the annual inflation rate reached 5.1 percent in the September 2008 quarter, during the global financial crisis.
Price increases were seen across ten of the 11 main groups in the CPI basket. Statistics New Zealand note that part of the annual increase was attributable to prices being measured against the June 2020 quarter, during the COVID-19 lockdown where some prices fell.
The weighted average price of a litre of 91 octane was $2.13 in the June 2021 quarter.
Annual transport prices increased over nine percent. Petrol prices increased 16 percent between the June 2020 quarter and June 2021 quarter. As the world faced COVID-19 lockdowns, petrol prices fell as world demand for crude oil reduced. Petrol prices have since increased as the global economy opens up further and uncertainty reduces. The weighted average price of a litre of 91 octane was $2.13 in the June 2021 quarter.
The cost of building a new house was the biggest contributor to both annual and quarterly inflation.
The difficulties addressing New Zealand’s high house prices by increasing supply is highlighted in the CPI release. Although house prices are not included in the CPI, the cost of building is. The cost of building a new house was the biggest contributor to both annual and quarterly inflation, up 7.4 percent for the year, and 4.6 percent for the quarter. Higher costs reflect high demand for building materials and ongoing supply-chain problems. In the year to May 2021, consented residential building work was up 18 percent on a year earlier.
Although greater than many expected, the CPI result is consistent with Reserve Bank of New Zealand (RBNZ) expectations of near-term inflation spikes in the June and September quarters.
RBNZ has signalled it is confident in New Zealand’s recovery, but concerned about inflationary pressures. The day before the CPI announcement RBNZ stated that “the New Zealand economy remains robust despite the ongoing impact from international border restrictions. Aggregate economic activity is above its pre-COVID-19 level. Household spending and construction activity are at high levels and continue to grow.”
RBNZ announced it will end additional purchases under the Large Scale Asset Purchase programme by 23 July 2021 in order to meet its inflation and employment objectives. However, RBNZ will keep the Official Cash Rate (OCR) at 0.25 percent. RBNZ expects that, in the absence of any further significant economic shocks, medium-term inflation and employment will remain below its remit objectives. However, inflationary pressure is expected to build over time due to rising domestic capacity pressures and labour shortages.
The potential for inflation to force interest rates to increase will be a cause for concern.
The higher than expected inflation and recent actions from RBNZ have many of the bank economists expecting the OCR to increase earlier in August 2021, much earlier than initially expected. Following the RBNZ announcement the big four banks, ANZ, BNZ, ASB and Westpac all increased mortgage rates. The potential for inflation to force interest rates to increase will be a cause for concern for government, those with mortgages or other debt, and households that rent.
If inflation continues to increase, and the June and September quarters are more than just spikes, RBNZ will be forced to respond. The OCR and interest rates will increase. This poses dangers for the recovery and the housing market. Higher interest rates will make borrowing more expensive and saving more attractive, reducing the incentive for consumers and businesses to spend and/or take on debt.
Increased interest rates will put pressure on recent first home buyers and renters. First home buyers, especially those who have stretched themselves to get onto the property ladder, will face higher repayments, meanwhile rents may increase as property investors seek to cover higher costs. New rules coming into force in October that will reduce the ability of investors to claim interest on loans used for residential property as an expense against income from the property will put further pressure on renters.
Interest repayments and rent increases reduce spending elsewhere in the economy. The next quarter could prove to be a pivotal point in New Zealand’s recovery. RBNZ faces a difficult decision on what to do with the OCR. Get it right and New Zealand’s strong recovery continues. However, getting it wrong could set the recovery back.