Inflation increases the risk of rates hike

Non-tradables inflation increases the risk of yet another rate hike in New Zealand

(See attached file: NZ_CPI2q_16jul07.pdf)

Inflation pressure continued to build in 2Q, with headline inflation posting a larger than expected gain of 1.0%q/q (JPMorgan and consensus 0.7%). More concerning for the interest rate outlook, however, was the 1.1%q/q gain in non-tradables inflation* - especially growth in prices emanating out of the housing market. The strong rise in non-tradables inflation to 4.1%oya (remaining above the psychological 4% level) has increased the risk of yet another tightening in July. That said, the fact that the most recent three RBNZ tightenings (implemented in March, April and June) are currently working their way through the economy, JPMorgan maintains the view that the RBNZ will remain on hold in July. With headline CPI at 2%oya (down from 2.5% in 1Q), a sharp drop in business and consumer confidence, growing signs of a turning housing market, and the continued strength of the Kiwi dollar, the RBNZ can afford to sit tight and better gauge economic developments.

The headline CPI gain of 1.0%q/q was boosted by a 2.4%q/q rise in the transport-related group (as petrol prices spiked 8%q/q). If petrol prices had remained flat over the quarter, the headline CPI would have risen 0.6%q/q. Non-tradables inflation was again driven by prices emanating out of the housing market. Housing and household utilities were up 2.6%q/q. Headline CPI excluding housing related prices rose 0.8%q/q and is now just 1.1%oya - down from 1.9%oya in 1Q and 3.7% in 2Q06. The rise in the housing group was stimulated by a 3%q/q surge in electricity prices, and a 1.6% rise in the purchase of new housing.

With non-tradables inflation remaining above 4% in 2Q, JPMorgan believes the risk of yet another RBNZ tightening in July have risen after today's report to 40% (previously we had believed the risk was 30%); but due to a one-off spikes in the report (namely petrol and electricity) this will not be enough to push RBNZ officials across the line.

* Non-tradables are goods and services that do not face foreign competition.

ENDS

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