Opinion: Inflation falls to 4%...or does it?

Post by David Cunningham - Squirrel CEO

Yesterday, Statistics New Zealand released our latest inflation data, tracking the numbers for the period from January to March 2024.

You may have caught the Stuff headline about it, emblazoned across the site shortly after the announcement, which read 'Inflation rate drops to 4%'.

Now, there’s only ever so much detail that can be captured in a headline, but I don’t think this one quite tells the whole story. And Stuff’s not to blame for that.

To explain what I mean, let’s take a look at the graph below, which depicts New Zealand’s inflation rate, on a quarterly basis, over the last five or so years.

The annual inflation rate is calculated by adding up the last four quarters (on the right-hand side of the graph). That’s the 4.0% referenced in the Stuff headline – a number which falls well outside the Reserve Bank’s targeted inflation band of between 1% and 3%.

But that calculation includes data that’s almost a year out of date. It’s a rear-view mirror look at quarterly inflation. So, is it the best measure of the reality today?

In my opinion, the forward view is what matters, not just what’s in the rear-view mirror.

To get a more accurate picture of what’s been happening more recently, a better approach might be to add up the last two quarters of data and annualise that figure (i.e. multiply it by two).

1.1% x 2 = 2.2%

If you were to do that, the annualised inflation rate, based on the last six months of data, is actually running at 2.2%. And if that’s the case, that’s well inside the Reserve Bank’s targeted inflation band of 1% to 3%.

In response to the latest inflation stats, major bank economists are - universally - sounding huge doses of caution against dropping the OCR any time soon

Their commentary focuses on the 4% number, the stickiness of non-tradeables inflation, and points out the risks of inflation accelerating.

Several things get a special mention as causes for concern on the inflation front, including rising rents, rates, insurance, tobacco prices and…Taylor Swift (as Kiwi spent up large to go to her concerts across the ditch).

Interestingly, you could characterise most of these as taxes (including a tax on ‘fun’) but as far as fighting inflation goes, monetary policy i.e. what the Reserve Bank does with interest rates, won’t make the slightest bit of difference to any of them.

By arguing that the latest inflation stats are grounds for the RBNZ to keep the Official Cash Rate (OCR) higher for longer, the implication is that more damage must be done via interest rates, delivering lower inflation elsewhere, in order to mitigate the inflationary impact of these other factors.

And I’m not sure there’s a lot of merit to that approach.

Holding out on dropping interest rates will only cause more, unnecessary economic pain for New Zealanders

I’ve written previously about the fact that the impact of monetary policy takes one to two years to flow through the economy, largely due to New Zealanders’ preference for fixed-rate home loans.

In other words, the last two quarters of inflation outcomes reflect the dramatic tightening in monetary policy one to two years ago.

What the banks’ perspective on yesterday’s announcement fails to take into account is all the other economic data out there – including shrinking GDP figures and sales data – which show that Kiwi are already doing it incredibly tough.

And we still haven’t felt the full impact of all the OCR increases we’ve had over the last two years. There’s more to come.

Based on current interest rates, home loan borrowers will, on average, experience another 1% rise in mortgage rates. This is because the average fixed-rate home loan Kiwis are currently paying is below 6% compared to current market rates, which are nearer 7%.

So, by holding the OCR at current levels, the Reserve Bank is effectively continuing to tighten monetary conditions.

If you think the economy is weak today, watch out. There’s a lot more pain ahead. I wouldn’t be surprised to see New Zealand remain in recession for some time to come.

So the question I’d put to the Reserve Bank is this:

Should you be tightening monetary conditions in the face of continuing recession and (actual) annualised inflation at 2.2%?  Or is it time to signal that the hard yards are behind us and that gradual reductions in the Official Cash Rate are imminent?

And I, for one, am very much in the latter camp.

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