I was a bit confused when I heard a claim from Roger J Kerr that September quarter consumer price growth was only going to come in at 0.4%, leaving annual growth in the CPI at around 4%.
His justification for the weakening outlook for growth in the CPI was a softening in petrol prices – something that has indeed happened over the past four weeks. Although many of the point he raises are extremely relevant I feel that his conclusion (which implies that inflationary pressures are on the decline, that the RBNZ should feel more comfortable about cutting interest rates, and that the price increases in September will be that weak) appears to be well off the mark. Let me discuss why I think this:
Petrol price have fallen!
Yes, yes they have. However, the fall in petrol prices experienced over the last month is definitely not sufficient to get quarterly growth down to 0.4%.
According to the retail petrol price figures provided by MED the average petrol price over the June quarter was $1.95 per litre. Now, fuel prices are not even below that level yet. As a result, we would need a substantial, and sustained, fall in petrol prices over the next 6 weeks for petrol prices to be a negative contributor to the consumer price index over the September quarter.
Furthermore, petrol only accounts for 5.8% of the consumer price index (this is its weighting here – table 9A). As a result, we would require a substantial change in petrol prices (compared to expectations) in order to significantly impact on the CPI.
In order to cause the associated claim in Mr Kerr’s article:
The recent decreases in petrol and diesel prices should translate in the CPI increase for the September quarters being closer to +0.4% than the +1.3% featuring in RBNZ and most economists forecasts
We would need petrol prices to be 16% below expectations over the quarter – nothing of this magnitude has occurred.
Ok, but there appears to have been price reductions in some other areas
I completely agree – electricity price growth has cooled since mid-July and there are reports that retail firms are discounting big ticket items because of overstocking.
Of course, food prices have continued to rise at a rapid rate ($NZ beef prices are up 40% on a year earlier – this pressure will come through at supermarkets) and the exchange rate has dropped a lot more rapidly than the RBNZ or other economic forecasters expected – a factor that will increase growth in the CPI.
Furthermore, business margins are tight – as a result, any reduction in costs, or increase in domestic spending pressure over the September quarter is likely to lead to higher prices rather than an increase in domestic production.
One other thing to remember is that the Sep 07 quarter was weak because of government subsidies – this has lead to an underestimation of “inflation” and as a result there is going to be a technical boost now. Furthermore, the September quarter is a common quarter for wage negotiations in large organisation (given the common use of the July year) – as a result, rising wages will push up prices! A 0.4% quarter is highly unlikely.
As a result, annual CPI growth of 5% appears just as likely as it did before. I hope it doesn’t occur, but it is a definite possibility.
But if it is weaker, then that is game over for inflation – its easing time!
No. I have tried to avoid calling CPI growth inflation because, its not really.
We have discussed inflation in detail during the inflation debate (which will continue at some point 😛 ), and we realised that we are interested in the rising general price level – not changes in the relative price of things like fuel.
Now, the RBNZ looks at things in a demand side sense. The cut in interest rates increases demand, if it randomly contracts below where it should be. Now, falling petrol prices will increase demand – as it is equivalent to an increase in income (especially since demand for fuel is inelastic). As a result, a fall in petrol prices will make it LESS likely that the RBNZ will cut interest rates.
I suspect that they cut in July (compared to the September date they were implying) because petrol price rose MORE quickly than they expected – implying that domestic demand would contract more quickly. Given this, the fact that petrol prices have eased from their July peak does not imply that the RBNZ can start cutting rates – infact it implies the opposite.
Ultimately, it is a question of true inflation expectations – what inflation premium do firms add to their product markups and what premium do workers add to their wage demands. It is the RBNZ’s responsibility to anchor the value of this premium – something the Labour cost index suggests that they are having trouble with.
Even though lower petrol prices will reduce expected growth in the consumer price index – do they imply that we will have weaker growth in the general price level? The general experience is that they don’t – unless the Bank allows inflation expectations to wander around without any anchor. However, it is the impact on expectations we have to control – not the fact that the relative price of petrol to other goods has changed (trying to stop relative price changes will be inefficient – as it screws up the allocation of resources).
One more thing I would note is world economic growth. Petrol prices are falling because the world growth outlook is falling – if we believe this is going to feed into commodity prices THEN we are in a position where petrol prices are falling and we should cut interest rates. However, we don’t cut rates because petrol prices are falling – we cut them because we expect our countries income level to fall.
Feel free to disagree with me in the comments 🙂