No Beast, No More: Inflation. The Unbridled Beast Of Old Is Now Tiny And Tame

• Welcome to 2025. There’s still a couple hurdles to jump over. But we’re excited for the recovery that 2025 should bring. Business confidence keeps climbing (see COTW).
• This week, we’re right back into it. The latest Kiwi inflation print for Q4 is due out on Wednesday. By our calculations, we see inflation slowing a smidge to 2.1% from 2.2% - the lowest since June 2021.
• With the Kiwi dollar under the crunch, it’s a good time to revisit our last episode of Markets, Mystics & Mayhem. As we had thought, interest rate differentials, helped by the ‘Trump Trade’ has seen the Kiwi trade below 56c. Bang in line with our call for the Kiwi to hit 55c.

Here’s our take on current events

Welcome to 2025. It should be a much better year than last year. We’re going into 2025 feeling optimistic for the Kiwi economy with rates continuing to fall and inflation stabilising at 2%. Yes, there’s still a couple of hurdles to get through. And we’re bound to get some surprises along the way. But ultimately, we’re excited for the recovery that is coming. Be sure to check out “Pick a path: ‘Alive in 25 or ‘Thrive in 25’ ’” for more on our outlook for the year ahead.

For now though, we’re getting straight into it with a lot on the calendar. We’ve already seen a significant lift in business confidence with the release of NZIER’s Quarterly Survey of Business Opinion last week (see our COTW for more). And this week we’re gearing up for the latest snapshot of Kiwi inflation – out on Wednesday.

We’re expecting some good news for the final quarter of 2024. By our calculations, we see inflation slowing a smidge to 2.1% from 2.2% - the lowest since June 2021. Over the quarter, we expect consumer prices rose 0.4%, a deceleration from the 0.6% in the September quarter. Our forecasts are broadly in line with the RBNZ’s expectations.

We can thank imported inflation for driving headline inflation back towards 2%. Indeed, today’s inflation is all homegrown. We expect annual tradables to remain in negative territory (deflation) at -1.3%. Fuel prices have been especially weak. According to StatsNZ, petrol prices fell more than 1% over the quarter. Providing some offset, however, will be the rise in airfares. Over the past three months, domestic airfares rose 9.4% while international airfares increased 6.9%. Arts and recreation, specifically accommodation costs, will likely see a boost. That’s typical over the holiday months. Similarly, seasonal weakness in fresh produce has seen food prices overall record a 0.6% decline over the quarter.

Domestic inflation, in contrast, is a slow-moving beast. The good news is that it has turned. We expect annual non-tradables to slow to 4.5% from 4.9%. It is some distance from the 6.8% peak, but is still sitting high above the long-term average (~3%). A more meaningful slowing in services inflation is needed to ensure a sustainable return to 2%. On this front, spare capacity continues to grow within the economy and the labour market has undoubtedly softened. That’s key for a further cooling in services inflation.

For the RBNZ, the underlying trend in inflation is more important for policy. Core measures of inflation strip out the volatile price movements. Encouragingly, core inflation has been trending south since hitting the 6.7% peak at the end of 2022. In the year to September 2024, core inflation fell to 3.1%. We expect more progress was made over the December quarter, with measures of core inflation falling back within the RBNZ’s target band.

All up, Wednesday’s update, if as expected, should keep the RBNZ on course to deliver another 50bp cut to the cash rate at its February meeting.

Charts of the Week: Confidence keeps climbing.

The improvement in business sentiment continues. The NZIER’s quarterly survey of business opinion (QSBO), the best on the street, showed a further lift in business confidence. In the December quarter, a net 9% (seasonally adjusted) now expect economic conditions to improve in the coming months – a starkly different result to the net 4% of firms in the September quarter expecting a deterioration in the economic outlook. It’s the first positive outlook in over three years (since the June 2021 quarter), and the highest reading since 2017. After hitting a series-low at the end of 2022, business confidence has been on a slow road to recovery. There was a brief improvement following the change in government. But it has been the pivot in monetary policy that has prompted a stronger, seemingly sustained, lift in sentiment.

There is light at the end of the tunnel. But it’s still some distance until we’re out of the shadows. According to Kiwi businesses, it is still a challenge to navigate the current economic environment. Experienced activity levels remain subdued, with ongoing weak demand. A net 26% of firms reported a decline in trading activity. There’s risk the current recession is extended. The data points to yet another quarter of the Kiwi economy running backwards. At the very least, below-trend growth persists.

Expectations of activity however shows promise of a turnaround. A net 9% of firms expect an increase in activity in the next year. The dichotomy between what firms are experiencing and what they expect in terms of activity is clear. That is, businesses are more optimistic. But that optimism has yet to translate into activity, as well as any investment or hiring intentions. Investment intentions overall, while improved from last quarter, remain negative. In the year ahead, A net 14% of firms intend to reduce investment in buildings, while a net 5% intend to reduce investment in plant and machinery. It’s going to take time, and a sustained recovery in demand, before firms start investing again. However, when it comes to staff, it seems some firms are looking to expand their workforce in coming months. A net 5% of firms expect to hire over the coming quarter. Although, we still forecast the unemployment rate climbing further in the near-term. And the cuts to staff, with a net 17% of firms reducing headcount, confirms as much. So there’s still a bit more pain to come.

But back to some good news. We were excited to see more costs pressures easing. The December quarter saw the smallest proportion of firms experiencing increased costs since March 2021. Just 35% of firms experienced higher costs over Q4, a far fewer number than the net 41% last quarter and the net 56% last year. Thanks to falling costs, profitability improves. Yes, there’s still a long way to go before profitability truly returns. A notable share (net 36%) of firms reported a decline in profits last quarter – but that share is shrinking. High inflation coupled with weakening demand had hurt firms’ profitability. But the inflation dragon has been slayed. That’s one (BIG) part of the equation solved. The next part is coming out of recession and seeing a return in sustained demand. And with interest rates having further to fall, we’re optimistic.

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