Inflation and a pay rise just around the corner

The increased cost of a packet of cigarettes is having an impact on inflation, but the overall economy could still be hotter. Photo: Lynn Grieveson

Annual inflation stood at just 1.1 percent according to data released by Stats NZ on Wednesday, but economists predict that number will rise as tightness in the Labour market fuels wage increases. Thomas Coughlan reports.

The consumers price index (CPI) rose 0.5 percent in the March 2018 quarter, Stats NZ announced on Wednesday. Annual inflation stood at 1.1 percent, down from 1.6 percent for the year ended December 2017 and the lowest since 2016. The CPI is Stats New Zealand’s way of measuring price changes and is a good indication of whether certain parts of the economy are causing prices to increase or decrease. 

This quarter’s low inflation can largely be put down to the Government’s fee-free first year tertiary education policy, which saw prices for tertiary education plunge 16 percent in the quarter. It was the first time that series had decreased since 2003. Overall education prices fell 5.6 percent, the largest downwards contributor to the CPI.

Government policy also drove price increases. The cost of cigarettes and tobacco rose 10 percent  during the quarter due to the excise tax rise implemented in January. The average price for a packet of 25 cigarettes was $35.14 in March, compared with $31.68 last December. In the March 2010 quarter the same packet cost just $13.46.

Unsurprisingly housing costs continued to rise. Housing and household utilities made the largest upwards contribution to the 1.1 percent CPI increase for the year. The cost of newly-built houses increased 4.7 percent in the March 2018 year. The increase was highest in Auckland and Wellington, which saw the price of newbuilds increased 5.8 percent and 3.2 percent respectively. 

Rents also increased. Nationally, rents rose 2.1 percent over the year. Wellington rose fastest, with rents increasing 4.2 percent over the year. Auckland was lower at 2.5 percent and rents decreased 1.5 percent in Christchurch. 

This data shows a slight levelling off in the increase of rents in Auckland, perhaps driven by the fact rents are already at the upper limit of what people can pay, or by people changing living situations by putting more people in a rented home. The decrease in Christchurch is evidence more post-earthquake housing may have led to a rental glut. 

Independent economist Cameron Bagrie said the CPI data showed evidence of an economy with not enough aggregate demand.

“The big issues is, is there enough in the aggregate demand or the growth story of New Zealand to get inflation back towards two percent,” Bagrie said. 

“If you’re looking at growth in itself the answer is probably ‘no’ because the economy is just not running hot,” he said. 

A pay rise in the pipeline

The Reserve Bank watches inflation data closely. It's goal is to keep inflation within a band of one to three percent and to have inflation average two percent over the mid-term. This is thought to be ideal because it balances the desirability of price increases for positive reasons, like increased wages, with the negative impacts of prices rising too fast. 

The Reserve Bank tries to control inflation through the Official Cash Rate, which sets interest rates in New Zealand. It lowers the rate and decreases the cost of borrowing when inflation is too low, and raises the rate, increasing the cost of borrowing when inflation is too high. 

This data shows the inflation getting to the very bottom of the Reserve Bank’s target, but few economists believe the bank will be worried.

“I wouldn’t imagine they’d be panicking,” said Kiwibank senior economist Jeremy Couchman.

“They were expecting that this would be the trough in inflation for the time being and we agree with them in that respect so the signs are there that inflation will start to pick up through 2018 and I guess the question is how fast,” he said. 

The Reserve Bank had forecast annual inflation would fall to 1.1 percent in this quarter, but would rise to 1.7 next year and 1.8 in 2020 before hitting the targeted two percent in 2021. 

Couchman said he was expecting tightness in the labour market and increases in the minimum wage to feed through into inflation later in the year.

Bagrie agreed wage increases were on the way and cautioned this could lead to higher inflation if wage increases were not accompanied by increases in productivity.

“We need to get the productivity story up to match the anticipated growth in wages otherwise there’s going to either be a squeeze on margins or there’s going to be inflation in the system,” he said. 

He said the lukewarm economy presented several different scenarios.

“It’s a low probability, but there’s a scenario that the Reserve Bank might have to cut rates,” he said.

“They said last year that’s an option that is still on the table because the economy just on the face of it doesn’t appear hot enough to lift the inflation story up."

Alternatively, if there was more inflation than the Reserve Bank anticipates it is likely to increase rates to contain it.