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Inflation Is Rising And So Are Interest Rates.

Inflation rose a massive 1.3% in the June quarter, much higher than consensus of 0.7%, and even our 1.0% pick. Prices rose 3.3% over the year, with chunky gains in construction costs, transport costs, Food, and… the gains were broad based. Core measures of inflation also printed between 3-to-3.3% over the year. Inflation is now ‘officially’ above the RBNZ’s mandated 1-3%yoy target band.

We have seen a quantum shift in expectations and business confidence. And we’re in a different pricing environment. Businesses are less worried about demand and more worried about supply.

We now expect the RBNZ to lift the cash rate in August, in what will be the first of at least three hikes from here. An earlier lift off from the RBNZ will (hopefully) mean less work will need to be done to restrain the economy in the future.

It’s confirmed! Inflation is accelerating and is now through the top of the RBNZ inflation target band. Inflation is set to hold above the top of the target band next quarter. June quarter CPI inflation came in above our expectations at 1.3% in the quarter according to StatsNZ, and annual inflation hit 3.3% - the highest rate in over a decade. But a jump in annual inflation from 1.5% at the start of 2021 was expected. In part because of the base effects from last year’s lockdown induced fall in prices. The last time the annual inflation rate tested such heights was in June 2011, rising to 5.3% due to GST hikes.

What was most interesting was the broad-based nature of inflation pressure evident in today’s report. Demand in the economy has been consistently strong since coming out of last year’s level 4 lockdown. And combined with supply side constraints – such as firms facing challenges in sourcing labour and materials – we have a recipe for price rises. Almost all groups in the CPI basket recorded price rises. Core measures of inflation have also strengthened. Both tradables (imported) and non-tradables (domestic) inflation popped back up in the June quarter.

Some of the key drivers of inflation are expected to be transitory. Global supply-chain disruption should be addressed as the world gets back to a new normal – taking the pressure off shipping costs. Labour shortages will hopefully abate next year as our, by then, vaccinated country starts the process of opening back up to the world. But for the RBNZ, these transitory factors could easily turn into permanent inflation in the current atypical environment. So, something has to give, and the RBNZ is now willing to oblige.

We are in a different pricing environment, one where businesses are much more willing and able to pass on higher prices. Businesses are less worried about demand, and more worried about supply.

We now expect the RBNZ to lift the cash rate in August, in what will be the first of at least three hikes from here. We’re likely to see two hikes by year end, and a push to 1% by February. Beyond 1% will depend on the interest rate sensitivity of the economy coming off record low rates. We have pencilled in another lift in the cash rate to 1.5%, but likely to be all we see in the near-to-medium term. An earlier lift off from the RBNZ will (hopefully) mean less work will need to be done to restrain the economy in the future.

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