Finally some good inflation news

Finally some good inflation news

Middle aged woman looking at phone, smiling

In my last column on interest rates written two weeks ago I discussed the increasing probability that interest rates have peaked. That probability got a lift this Thursday with the annual inflation number. The 6.7% rise in consumer prices in the year to March was lower than the 7.1% commonly expected in the financial markets and importantly the 7.3% expected by the Reserve Bank.

That 7.3% expectation would have been a key factor behind the Reserve Bank’s decision on April 5 to raise the official cash rate by 0.5% and not the 0.25% which people had been expecting. The data show that the Reserve Bank were out by 0.6% and this is exactly the amount by which the September year inflation rate released on October 18 was above market expectations.

Does this mean we will now see a rapid decline in interest rates?

Will we reverse the extra 1% added to fixed mortgage rates in the few weeks which followed October 18 and the Reserve Bank’s strong reaction on November 23? The answer is no.

A lot of attention by us analysts in New Zealand goes on what we call the non-tradeables rate of inflation. This is a measure which strips out items whose prices are determined by offshore factors, or which are imported from overseas. This non-tradeables inflation rate actually rose from 6.6% to 6.8%. That is bad. But the Reserve Bank had expected 7.1%.

Also, another measure of underlying inflation which strips out the top and bottom 10% of items changing in price fell to 5.9% from 6.5% three months ago and a peak of 7%.

Things are moving in the right direction

And there is downward pressure especially coming soon from the unwinding of the house construction boom which will likely see some falls in construction materials costs.

On April 5 when the Reserve Bank raised the official cash rate 0.5%, they withdrew their warning that interest rates would need to be pushed higher. They instead said that rate decisions going forward would now depend on what happened with inflation measures and whether domestic demand was reducing enough.

The lower than expected inflation outcome will be a key factor underlying their discussions heading into the next rate review on May 24. The chances that they will raise the cash rate by the final 0.25% which they indicated on November 23 have declined, but not gone away entirely. They will look closely at what is happening now with consumer spending etc. and where inflation expectations start going now that inflation will be generally discussed as falling.

What does this mean for borrowers?

The incentive to fix one year and ride rates down when they do start falling has increased. There is even a chance that the banks which have not yet raised their one and two year fixed rates since the April 5 0.5% cash rate rise will continue to hold off from doing so. Maybe those which raised their rates will give consideration to cutting them back down again.

Those decisions will be driven a lot by internal bank targets for market share about which we have zero information. So, nothing can be ruled in or out. But the general discussion now is going to shift towards inflation falling and the pace at which it will be heading down. There is a risk that the Reserve Bank will seek to curb people’s optimism about inflation and therefore interest rates falling with some still strong comments come May 24 if not before then should the opportunity present itself.

The last thing our central bank will want is to see optimism drive rate declines which they then have to engineer a reversal of because inflation still proves more intransigent than hoped.

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