Inflation data to September caught many forecasters with their pants down. The consensus had been that inflation would have peaked, but instead the data showed inflation is still running hot, at 7.2%pa, and is only a smidgeon below its 7.3%pa peak from June.
As always, the devil is in the detail, and so I have been quick to jump in and skim through the different inflation readings across industries.
This detailed analysis highlights that a clear transport and supply chain story is driving the headline – higher fuel prices, logistical disruptions, and weather events are leaving a legacy of inflation across large parts of the economy. Think transport, food, construction, and bulky items like furniture.
But there is also a scarier, more locally driven story that is permeating through the data, where every man and his dog is lifting prices to preserve margins and pass on cost increases.
It was particularly telling to see health and education inflation lift sharply. A year ago, inflation in these sectors was running at around 2%pa, while now we are seeing health inflation pushing up closer to 5%pa and day-care centres are lifting prices by just over 4%pa.
These key local services may not have the fastest inflation in our economy at present, but they are also not exposed to foreign forces. These are the types of examples for me where brewing inflation is of most concern, and today’s result reinforces that we are still some way before inflationary expectations are fully reigned in.
In terms of how the Reserve Bank of New Zealand (RBNZ) will react to inflation – most commentators are now saying that the Bank will do a 75-basis point increase in November.
What’s my opinion on that?
Well, it might happen, but I think it could be a mistake to be so aggressive.
The RBNZ still clearly needs to maintain a tightening bias to put a lid on inflation and protect the dollar, however, it also needs to be careful not to engineer a recession.
There is already a hell of a lot of monetary tightening in the system that is yet to flow through to households. The average fixed mortgage rate being paid by households is currently only 3.68%, compared to the 5.5% to 6% advertised fixed mortgage rates households will pay when they refix their mortgages over the coming months. As households refix, they will be paying the equivalent of another $10,000 per year of interest on a half million-dollar mortgage which is going to hurt a lot and cause households to cut back spending.
Given that the pain is still to come, my advice to the Reserve Bank is to cool the jets and to follow the lead of our peers across the Ditch. The Reserve Bank of Australia (RBA) recently opted for just a 25-basis point increase to its target interest rate. Our friends in Australia know they still have a way to go on inflation, but the RBA is also terrified of going to hard and unleashing a recessionary beast from overburdening mortgage-exposed households.
We should take note of these concerns in New Zealand. We need to let the rate hikes that have already occurred work their way through the system! Remember, that the pain that has already been baked into the system is still to come for most New Zealand households.