Inflation's backing down, but it's still got a way to go

Inflation's backing down, but it's still got a way to go

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If borrowers are hoping that the just-announced fall in the country’s rate of inflation to a four year low of 4.0% from the 2022 peak of 7.3% will bring interest rate cuts, best think again. On the face of it, the fact that prices on average only rose by 0.6% in the March quarter and 0.5% in the December quarter — or 2.2% annualised — should indicate interest rates can solidly decline.

The Reserve Bank’s target is 1-3%

And we seem to be headed there, if not we're there already. However, while the measure they target is headline inflation, the measures they use as a guide to what is really happening underneath the various ups and downs of the 649 items covered are not tracking so well.

Consider, for instance, the difference between inflation in prices of things we import or export – tradeable inflation – and inflation in prices of items which prices are actually set in New Zealand – non-tradeable inflation.

The prices of tradeable goods fell 0.7% in the March quarter, and 0.3% in the December quarter. But non-tradeable items which have their prices affected by monetary policy changes rose 1.6% in the March quarter, and 1.1% in the December quarter.

This measure, alongside other gauges of “core” inflation is not anywhere near where it needs to be for the Reserve Bank to seriously contemplate sending a signal of happiness about inflation.

This is in spite of the fresh deterioration in economic conditions underway in our economy and evident in some of my surveys.

For instance, whereas in December only a net 13% of consumers in my Spending Plans Survey said they plan cutting back on spending, now a net 30% do. The outlook for retailers and home builders has deteriorated anew.

A key cause of the deterioration is the now rapidly weakening labour market.

In my survey of real estate agents undertaken just over two weeks ago, 37% said that they can see that buyers are worried about their jobs and incomes. That proportion was 24% a month ago and just 14% in January.

These new deteriorations at a time when the economy is already in recession tell us that monetary policy tightening has definitely had a strong impact on the economy. But the transition through to inflation consolidating safely below 3% has yet to happen.

In fact, it pays to note that in some countries including the United States the earlier optimism about inflation continuing to fall has stalled. Their rate seems stuck above 3% and prospects for the Federal Reserve to cut interest rates this year have become a lot dimmer in recent weeks.

For now, borrowers should anticipate rates to stay broadly where they are

This of course depends on whether banks want to aggressively compete for business or not. I can see from my monthly survey of mortgage brokers that lending criteria are slowly easing and a net 20% of brokers feel that banks are becoming more willing to lend.

But with unemployment heading towards 5%, and more businesses failing – especially in the construction sector – the extent of any competition-driven easing in mortgage rates is likely to be small.

I still think we are on track for monetary policy to be eased before the end of the year. But until the core measures of inflation track alongside the headline measure near or just below 3%, borrowers should contain their optimism.

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