Our Take: Winter is coming

Winter is coming: as inflation cools to the core and supports RBNZ rate cuts.
Core measures of inflation eased into 2019.

Key points

• The Kiwi inflation report was weak, very weak.

• Coming in below even the RBNZ’s low estimate, the inflation print supports the case for interest rate cuts.

• The market moved, immediately, to price in a greater probability of RBNZ rate cuts, and the Kiwi dollar fell.

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Summary
Inflation was much weaker than we and the market had expected in Q1, and even missed the RBNZ’s own weak forecast. Inflation edged 0.1%qoq higher, the same as the December quarter, and meant that annual inflation rate dropped to 1.5%yoy. Once again inflation was driven by the opposing forces of solid non-tradables (domestic) inflation and falling tradables (or imported) inflation.

Driving to the Four Square to buy cigarettes may have cost less in petrol, but the rising cost of cigarettes offset the drop in the fuel bill. Petrol prices were down 7% on the quarter, and combined with a mighty 12%qoq fall in international airfares. The price of cigarettes rose 7.7%qoq. Offsetting the 1.2%qoq fall in tradables inflation, was a 1.1%qoq rise in non-tradables inflation.

Domestically generated inflation is stronger, running at 2.8%yoy. But, the outlook is deteriorating. The core measures of inflation took a downward step in Q1, and lost some momentum. Core measures strip out the volatile stuff like cigarettes and petrol. And core measures offer some guidance on future price settings. StatsNZ’s trimmed mean measures (a technical way to strip out volatile price movements) were lower across the board. The loss in price setting momentum concerns us, and RBNZ officials . Given the solid growth we’ve seen, the tightness of our labour market, and the cost pressure experienced by Kiwi firms, we should see higher (pass-on) inflation. The fact we haven’t seen the push higher in inflation, explains the lack of business confidence, and weaker starting point we find ourselves in 2019.

Given a deteriorating economic backdrop, globally, the lower starting point on inflation is a worrying sign for the RBNZ wanting to get inflation back to a 2%yoy target midpoint (or higher). Today’s report gives the RBNZ’s new Monetary Policy Committee plenty of food for thought heading into the May MPS. Today’s report supports the need for a cut in the OCR to 1.50% in May.

There was a swift reaction in markets to the CPI report. The dollar lost a cent to 0.6700 and wholesale interest rates are lower. The market has quickly moved to price a 65% chance of a rate cut in May, up from ~30% chance before the CPI print. We have been calling for a May rate cut, assigning a 60% chance. Today’s data suggests there is now a higher probability, closer to 70%. Market traders agree. The chart below shows the sharp drop in headline inflation, relative to recent RBNZ forecasts. It’s a downside surprise… And the RBNZ have a downward bias.

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