Finally, inflation back over 2 percent midpoint

Annual inflation rose to 2.2 percent in the March quarter from 1.3 percent the March quarter. It was the highest rate since September 2011. Chart from Statistics NZ.

Annual inflation finally rose back above the 2 percent midpoint of the Reserve Bank's 1-3 percent target band in the March quarter - five and a half years after it was last above the key level.

Vegetable, petrol and cigarette prices rose sharply, as did rents in Auckland. Underlying inflation picked up slightly, raising questions about whether the central bank will hike interest rates sooner than the end of 2019 -- which it forecast in February. The New Zealand dollar rose around 40 basis points to 70.4 USc after the result, which was slightly stronger than expected.

Governor Graeme Wheeler agreed in his 2012 Policy Targets Agreement to keep future Consumer Price Index (CPI) inflation between 1 and 3 percent over the medium term, "with a focus on keeping future average inflation near the 2 per cent target midpoint." This is the first time in his five year term that annual inflation has risen above that level. His term ends in September and he will not be serving a second term. Deputy Governor Grant Spencer, who is also retiring, is due to serve a six month term from September while a permanent replacement is found and can agree a new PTA with whoever is Finance Minister after the September election.

Statistics New Zealand reported the Consumer Price Index rose 1.0 percent in the March quarter from the December quarter, which lifted the index 2.2 percent from the March quarter of 2016. This was the fastest annual inflation rate since the September quarter of 2011, which was the last of the quarterly inflation figures affected by the October 2010 increase in the GST rate from 12.5 percent to 15 percent.

The 1.0 percent quarterly growth rate was above the median economist forecast for inflation of 0.8 percent and above the Reserve Bank's February forecast for a 0.3 percent rise.

Economists pointed to one-off rises in fruit and vegetable prices (7.1 percent for the quarter due to weather effects), cigarettes (9.7 percent due to tax increases) and petrol (4.1 percent due to higher oil prices) as factors behind almost two-thirds of the 1.0 percent rise in the index. Annual inflation excluding food, petrol and energy, was stable at 1.6 percent.

However, higher prices for home rentals (0.8 percent for quarter) and new homes (1.0 percent) were more structural factors in the rise in inflation, along with higher than expected rises in the prices of tradable items such as furniture and furnishings (up 1.5 percent), household textiles (3.9 percent) and domestic air travel (5.7 percent). Auckland rents rose 0.7 percent in the quarter and were up 3.1 percent from a year ago. Auckland rental inflation is up from 2.2 percent through most of 2014.

Economist reaction

Economists pointed to potential growth in profit margins for retailers and ongoing pressure on house building and rent costs as factors lifting inflationary pressures. But they said the firming was not enough to prompt any immediate lift in the Official Cash Rate, which is seen unchanged at 1.75 percent until well into next year.

"The stronger than expected result, including signs that tradables inflation may have more momentum than we had anticipated, does suggest some upside risk to our view for the Official Cash Rate," said Westpac Acting Chief Economist Michael Gordon.

"We expect the current lift in headline inflation will be temporary, as does the RBNZ, given there were several ‘one-offs’ in Q1," said A SB Chief Economist Nick Tuffley, adding he saw inflation hovering around 1.5 to 2.0 percent over the next few years.

"As such, downside risks to inflation, especially those stemming from weaker inflation expectations, have significantly reduced over the past six months. We continue to expect the RBNZ will lift the OCR in late 2018, around a year earlier than the RBNZ forecast in February," he said.

"With the economy increasingly butting up against capacity pressures, we do expect domestic inflation pressures to broaden further beyond housing and into the labour market," ANZ Chief Economist Cameron Bagrie said.

"However, there is still only modest evidence of this occurring at this stage (although the latest equal pay ruling should add some impetus). And with the impact of food and petrol price gains set to be temporary, and plenty of questions surrounding the global inflationary backdrop, it is certainly not guaranteed that headline inflation remains around current levels for a sustained period," he said.

"Today’s data reinforces that the next move in the OCR will be up. While acknowledging the uplift in some core inflation gauges, we doubt there is enough evidence in the breadth of moves to spur the RBNZ into shifting its stance just yet, especially with financial and credit conditions tightening independently of the OCR."