NZ: CPI inflation to jump, but core inflation and wages are key - HSBC

Analysts at HSBC note that for several years, a key challenge for the RBNZ has been to try to get CPI inflation to run at its ‘near 2%’ target and unlike in earlier times, the challenge has been that inflation has been too low, not too high.

Key Quotes

“Indeed, the last time headline CPI inflation was at 2% or higher was 3Q11. This streak of low CPI inflation may now be finally coming to an end. Rising petrol and food prices, plus some helpful base effects, mean that CPI inflation is forecast to rise to 2.1% in 1Q17, when it is published on 20 April. Combined with strong growth, this on-target inflation result has meant that RBNZ observers are beginning to ask when the central bank may start to lift its cash rate.”

“The answer relies on a deeper look at the RBNZ’s reaction function. To start with, the RBNZ has been cautious in its guidance. A recent speech by Governor Wheeler suggested that the risks around the direction of the next policy rate move were evenly balanced and the RBNZ’s own forecasts show that the policy rate is expected to be steady until 2019. Part of the reason for the cautiousness is that inflation has been below target for such a long time. It may also reflect that the 100bp of hikes that the RBNZ delivered in 2014, in response to inflation concerns, appears to have been overzealous, given that in the subsequent period, inflation fell, rather than rose.”

“For the RBNZ, a key question is how much of the recent lift in inflation will prove to be permanent? After all, much of the rise is expected to be due to petrol and food prices, which we expect to prove to be a temporary boost to the CPI. With this in mind, we expect the RBNZ to be focused on three things: the core measures of inflation; surveyed inflation expectations; and, wages growth.”

“Core inflation has lifted over the past 18 months, but is only around 1.5-1.7% y-o-y, which is still below the ‘near 2%’ target. Measures of inflation expectations are also rising, but are still below 2%. Finally, there are no signs of a pick-up in wages as yet. This reflects that there is spare capacity in the labour market, largely driven by inward migration. We think these variables will gradually rise over 2H17, but we see the RBNZ as remaining cautious, keeping its cash rate on hold in 2017. However, we do see these deeper factors as climbing enough to mean that a hike is likely by 1Q18.”