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Building inflation pressure could start to be a concern

HSBC Research_The RBNZ Observer: On hold, although inflation risks are rising

- While inflation was low in Q2, pockets of inflation pressure are starting to emerge and could start to concern the RBNZ

- At the same time, activity is strengthening, with indicators pointing to strong growth in H2 2013

- We expect the RBNZ to hold steady this week, but see the next move as a hike and expect it to come around year-end

Building inflation pressure could start to be a concern

While inflation was low in Q2 (+0.7% y-o-y), there are growing signs that it is picking up pace. This month brought the Q3 inflation expectations indicator, which jumped to 2.4% from 2.1%. While we expect the RBNZ to hold steady at this week’s meeting, we expect it to flag some growing concerns about the inflation outlook in its quarterly official statement.

In addition, the -6.4% fall in the NZD since April is also likely to see some upward pressure on the inflation outlook. Plus, construction cost inflation, on a quarterly basis, had already reached rates seen during the 2000s housing boom, in Q2 CPI numbers.

At the same time, timely indicators of business conditions suggest the local economy is going from strength to strength and is likely to hit capacity constraints fairly soon. The Canterbury rebuild will continue to boost the economy for a number of years. In addition, the housing market remains strong. We expect the recent rise in fixed mortgage rates and the imposition of LVR restrictions to be offset by the recent lift in inward migration.

Housing strength is also spilling over into the wider economy, with retail sales rising +4.3% y-o-y in Q2. The RBNZ flagged the potential for spill-over from the housing boom to other sectors as a key risk in its last policy statement, and this strength in consumer spending is expected to continue as interest rates remain low and the housing market remains solid.

The external sector story also looks positive. The drought was a drag on growth in Q2, but commodity prices have increased strongly in recent months. New Zealand’s terms of trade are close to the highs reached in 2011. Coupled with a lower exchange rate, this will likely provide a boost to rural incomes and confidence through H2 2013.

While low Q2 inflation should keep rates on hold this week, we expect the RBNZ may need to contemplate lifting rates soon, perhaps as early as year-end.


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