Heat on Reserve Bank to defend inflation target as living costs jump almost 5%

An asset price bubble and supply chain problems appear to have combined to produce fertile ground for inflation.
An asset price bubble and supply chain problems appear to have combined to produce fertile ground for inflation.

The Reserve Bank may need to rethink its stance on interest rates and next raise the official cash rate by 50 basis points to 1 per cent, after headline inflation rose to almost 5 per cent, Infometrics believes.

Annual inflation jumped more than expected to 4.9 per cent in the September quarter, Statistics NZ reported on Monday, putting inflation almost 2 per cent above the top of the Reserve Bank’s target band.

Infometrics principal economist Brad Olsen said the inflation figure – combined with a stronger-than-expected 2.8 per cent increase in GDP previously reported for the June quarter – put pressure on the Reserve Bank to consider its path forward.

Reserve Bank assistant governor Christian Hawkesby appeared to signal in a speech in September that it expected to raise interest rates in small steps.

But Olsen said there was a need to be realistic.

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Many forecasters had been changing their tune in recent times to say that higher inflation might be more persistent, he said.

“For the first time in a long time we have very high levels of inflation that look likely to continue building at least for the next few quarters.

“In our view, today’s inflation number does firmly put a 50 basis point raise in November on the table for the Reserve Bank to consider.”

The Reserve Bank is next due to review the OCR on November 24.

ANZ said underlying inflation was “too high” and the further removal of monetary stimulus was needed to get back on an even keel.

“With inflation this strong, the Reserve Bank won’t want to play fast and loose with their inflation-targeting credibility,” the bank said in a research note.

ASB chief economist Nick Tuffley expected annual inflation would rise above 5 per cent by the end of the year and said there was a clear risk high inflation would persist “well into 2022 and likely beyond”.

Reserve Bank former chief economist, John McDermott, explains how inflation is measured and how it manifests itself.

The annual increase in the consumer price index in the September quarter is based on comparing prices in the three months to the end of September with prices for the same basket of goods and services a year earlier.

Prices rose 2.2 per cent when compared to the June quarter, which Stats NZ said was the biggest quarterly jump since 1987 if the impact of a GST rise in 2011 is excluded.

Economists had been expecting inflation to rise because supply chain problems caused by Covid are constraining the supply of goods at the same time as higher house prices and relatively full employment are boosting people’s sense of wealth and their appetite for spending.

But there is no clear consensus on how long inflation may continue climbing and how serious it could become.

The Reserve Bank had been expecting annual inflation would rise, but by a lesser amount to 4.1 per cent.

It, along with bank economists, are generally forecasting higher inflation will be a relatively short-term phenomenon and that inflation will drop back to within the Reserve Bank’s target band of 1 to 3 per cent before long.

But some economists, including Waikato University fellow Leo Krippner, have highlighted similarities with monetary conditions in the 1970s, when inflation was often in double-figures before peaking at 18.9 per cent in 1987.

Westpac economist Satish Ranchhod described the 4.9 per cent inflation rate as well above market forecasts.

“Today’s result supports our forecast for a series of rate hikes from the Reserve Bank over the coming months,” he said.

The higher cost of building new housing is one of the larger contributors to rising inflation.
The higher cost of building new housing is one of the larger contributors to rising inflation.

Stats NZ said prices rose broadly in the September quarter, but the main drivers were housing-related costs, including increases in the construction cost of new houses and local authority rates.

Prices for the construction of new houses were up 4.5 per cent over the quarter, and up 12 per cent over the year.

“Both supply-chain challenges and high demand are pushing up the cost of building houses,” consumer prices manager Aaron Beck said.

“Construction firms reported that it is hard to get many materials needed to build a house and that there are higher labour and administration costs.”

The inflation data does not include the increase in the price of existing houses or of land for new housing.

Transport prices rose 4.2 per cent in the September quarter, due to higher prices for petrol, as well as international and domestic airfares.

Petrol prices rose 6.5 per cent in the quarter and 22 per cent for the year.

National Party finance spokesman Michael Woodhouse said the Government needed to “urgently recognise soaring inflation as the biggest medium-term threat” to the economy.

“The next big cost increase is unfortunately likely to now be mortgage costs as the Reserve Bank is forced to painfully increase interest rates as Kiwis and businesses try to recover from the current Covid outbreak,” he said.

The New Zealand dollar rose about a quarter of a US cent to US71c in the wake of the Stats NZ release, which could be explained by an expectation it makes larger interest rate rises more likely.