The price of inflation

Yes, NZ prices are rising too fast, but not as fast as in many countries, writes

The rapidly rising cost of living has been a shock to many Kiwis. With inflation running at 7.3 per cent — its highest level in 32 years — it is certainly the biggest economic problem the country faces right now.

In fact, it’s the biggest economic problem in the developed world.

How much of the blame lies with our Government — as opposed to how much is a symptom of global forces — has also become one of the hottest political issues of the day.

Somewhere between the extremes of political rhetoric there lies an answer.

But the bottom line — despite the hyperbole of some Government critics — is that New Zealand’s inflation rate is not among the highest in the OECD.

We’re very much middle of the pack.

If we add New Zealand to the list of G20 countries, we’d rank at number 11 of 21 — between India with a rate of 7.01 per cent and South Africa at 7.4 per cent.

The US and UK have annual inflation rates sitting at 9.1 and 9.4 per cent respectively.

The Euro Zone average is 8.6 per cent. Even European powerhouse Germany has an annual rate of 7.6 per cent. Further east it gets worse: Austria 8.7 per cent; Hungary 11.7 per cent; Greece 12.1 per cent; Czech Republic 17.2 per cent.

In Canada the rate is 8.1 per cent.

Australia has done better, with inflation taking longer to spike. But even there price rises are catching up fast, with the latest figures this week showing a rate of 6.1 per cent for the 12 months to the June quarter.

But doing relatively well on inflation compared to many of our peers doesn’t solve the price pain New Zealanders are feeling.

Nor does it absolve the Government of the responsibility to address the problem.

But it does suggest our policymakers are doing something right.

The big question for economists now is: has inflation peaked?

There have been some promising signs on global commodity markets, with oil prices falling back to around US$100 a barrel.

Food prices have eased — as reflected in falling dairy returns for Fonterra.

The prices of metals such as iron ore and aluminium are trending down and shipping costs are slowly retreating towards prepandemic levels.

The problem is how quickly we’ll feel those deflationary effects and whether they will be strong enough to overcome domestic inflation, which is on the rise as workers seek pay rises to cover costs and business try to pass those higher labour costs on to their customers.

“Yes, inflation is high — but we expect it to have peaked this cycle,” wrote ASB economist Mike Jones in a report this week.

“We’re cautiously optimistic the direction of travel is downwards, but it is going to be at a snail’s pace.”

The worry now is more about the persistence of inflation and not so much its peak, he said. “How long inflation remains elevated is a concern given the fact that households are already feeling the burn.”

In last week’s NZ consumers price index data, quarterly inflation rose by 1.7 per cent over the second quarter of the year, taking the annual rate to a peak of 7.3 per cent, the highest in 32 years

But as the ANZ economics team point out, it’s no longer just the headline inflation figure that will be worrying the Reserve Bank.

It is the surge in “nontradeables” and “core inflation” measures that is alarming.

The domestic portion of total inflation — which economists describe as non-tradeable — rose at an annual rate of 6.3 per cent to June 30 (up from 6 per cent in the year to March).

That was ahead of the Reserve Bank’s May forecast that it would ease to 5.7 per cent.

ANZ notes that non-tradeables prices account for just over 60 per cent of the consumers price index and capture goods and services that do not face international competition.

Hairdressing and personal grooming services were the quintessential examples, they said.

In that sector, annual price increases were 6.1 per cent in the latest CPI.

Equally concerning was the surge in what is known as core inflation.

Core inflation measures “aim to strip out volatile components (like petrol prices) to try to get at the underlying CPI inflation trend,” said the ANZ economists.

“Measures of core inflation now range between 4.8 per cent and 6.1 per cent, and have shown no signs of peaking.

“Even including 2010‘s GST hike, core inflation hasn’t been stronger in the past 20 years for which we have reliable data,” ANZ economists said.

All of that suggests a growing risk that inflation will stick around even after the transitory effects of Covid and the Ukraine war have passed through the annual data.

For the record, ASB forecasts that inflation will head down through the second half of this year and next before reaching the central bank Goldilocks zone (1-3 per cent) by March 2024.

Other bank economist forecast similar paths.

BNZ sees it drifting back to 5.2 per cent for the first quarter of next year, 4.8 per cent for the second quarter and a more manageable 3.3 per cent by the third quarter of 2023.

Thanks to a very tight labour market, the consensus is that domestic (non-tradeable) inflation will stay elevated even in the face of rising interest rates.

That means a gradual return to normal levels of inflation also depends on no further global supply shocks.

Given the volatility around commodities such as oil, that leaves plenty of risk that things could yet be worse than currently forecast.

But higher interest rates and recession — both globally and locally — or even just the threat of those things, are starting to do their job on economic demand.

As long as central banks hold their nerve, the path through this inflationary cycle remains manageable, particularly for strong dynamic economies like New Zealand’s.

"How long inflation remains elevated is a concern . . . "ASB economist Mike Jones