Consumer Price Index (Q1 2002)

Data Flash (New Zealand)
Consumer Price Index (Q1 2002)

Result: The headline CPI rose by 0.6% qoq in Q1, lifting the annual rate to 2.6% - slightly below market expectations. The release showed price pressure in the housing market.

Implication for markets: Bond yields fell by 2-3 points following the result, which was seen as having weakened the argument for a possible acceleration of the RBNZ's tightening pace. We continue to expect 25 bps rate hikes tomorrow and on 15 May.

The data

The CPI increased by 0.6% qoq in Q1. That lifted the annual rate of inflation from 1.8% to 2.6%.

The sharp increase in the annual rate is due to last year's negative Q1 CPI outcome (which reflected a one-off fall in state house rentals) dropping out of the calculation.

The result was below market expectations (+0.7% qoq) and those of the RBNZ (+0.9% qoq). As far as the RBNZ forecast error is concerned, it can partly be attributed to a somewhat better result for the volatile food component.

The key upward contributions were a 1.2% qoq rise in food prices (adding 0.22 pps to the result), a 1.4% rise in construction costs (+0.14 pps), a 2.3% increase in used car prices (+0.09 pps), a 2.8% increase in electricity charges (+0.08 pps), an excise tax related increase in prices of tobacco products (+0.08 pps), and higher health care costs (+0.06 pps).

Key downward contributions: Seasonal falls in international airfares of 8.1% (-0.21 pps) and stationery supplies of 11.1% (-0.05 pps), as well as a 0.8% average fall in prices of household appliances and furniture (-0.04 pps).

Analytical inflation measures:

Tradeables inflation was 0.0% qoq (+0.3% in Q4), with the annual rate unchanged at 2.5%.

Non-tradeables inflation was 1.2% qoq (+0.7% last quarter), which lifted the annual rate from 0.9% to 2.6%.

the CPI excluding fresh fruit and vegetables, petrol, and the effect of policy changes rose by 0.6% qoq (+1.0% last quarter). The annual rate remained unchanged at 3.0%;

the weighted median of quarterly price changes was 0.7% qoq (the same as in Q4); the weighted median of annual price changes remained unchanged at 2.5% (DB estimate).

Commentary

RBNZ's inflation view unchanged

Today's inflation result is unlikely to have changed the RBNZ's view of underlying inflation pressure in the economy. While it compared favourably with the forecast of 0.9% the RBNZ had printed in the Monetary Policy Statement of 20 March, the difference relates most likely to lower than expected food prices and a surprisingly large fall in the volatile airfares component. On the other hand, construction costs showed a solid increase, reinforcing the Bank's concern about an overheating housing market. The momentum in that sector is continuing and we can expect a similar increase for the housing component in the June quarter. At the same time, airfares are likely to rebound and the recent increase in petrol prices (including the excise tax related rise) will be reflected in the numbers. Deutsche Bank's preliminary estimate for the Q2 CPI is 1.2% qoq, which would take the annual rate of inflation to 3.0%. The expected fall in inflation of subsequent quarters is expected to be slow, which poses the risk of an increase in inflation expectations.

That prospect will keep the RBNZ determined to proceed with its rate rise programme foreshadowed on 20 March. We expect a 25 bps hike in the OCR tomorrow, followed by another 25 bps on 15 May. We do not consider it likely that the RBNZ will accelerate the tightening pace in May, as is currently priced by the market. Mixed international data, the recent firming of the NZD beyond RBNZ expectations, as well as signs that consumer confidence is coming off its highs (latest TV3 poll) suggest that the rationale for a more aggressive stance than announced in March is currently very weak.

RBNZ's inflation target too ambitious?

On a more general note about the conduct of monetary policy in New Zealand, it is interesting that the construction sector seems to be the only area where price increases clearly reflect demand driven price inflation. Other major contributions to the inflation relate to government policy changes (excise taxes), external factors (oil and food commodity prices) and structural adjustments (electricity charges, health insurance costs, structural depreciation of the exchange rate).

The text and spirit of the RBNZ's Policy Targets Agreement requires the Bank to `look through' the first round effect on inflation of most of those factors. The focus has to be on the medium-term trend in underlying inflation. Unfortunately, with upside influences of non-core inflation factors of significant persistence and magnitude, it has become increasingly difficult for the RBNZ to keep inflation expectations under control. Expectations by the business sector for inflation over the year ahead are currently around 2.7%, significantly above the desired medium-term inflation outcome of 1-2%. That suggests that the process of getting trend inflation back down to those levels is likely to be associated with a high cost, brought about by the effect of high interest rates on household and business activity.

The Reserve Bank of Australia is likely to have an easier job, considering that Australian businesses have expectations that are close to the mid-point of the 2-3% inflation target pursued by the RBA. With the RBNZ foreshadowing another aggressive tightening cycle by international standards, the question becomes again whether New Zealand's inflation target, which is below that of the US, the UK and Australia is too ambitious, thereby hurting the underlying growth prospects of the economy.

Ulf Schoefisch, Chief Economist, New Zealand

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