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Labour market data highlights resilience of New Zealand economy

By Christina Leung, Principal Economist for the New Zealand Institute of Economic Research


The latest September quarter Consumer Price Index (CPI) data showed continued intense inflation pressures in the New Zealand economy.

Prices increased 2.2 percent for the quarter to bring annual CPI inflation to 7.2 percent – just below the previous quarter’s 7.3 percent result but higher than the market and the Reserve Bank of New Zealand’s expectations. The result was also well above the RBNZ’s 1 to 3 percent inflation target band.  

Mixture of supply constraints and solid demand driving high inflation result 

One year on from when the RBNZ commenced its latest tightening cycle by raising the Official Cash Rate (OCR), high inflation pressures is still a feature of the New Zealand economy. The lower New Zealand dollar has put upward pressure on the price of imported household goods, while capacity pressures drove a further acceleration in non-tradable inflation. This was particularly apparent in sectors such as construction, where annual growth in residential construction cost inflation remains very high at over 16 percent.  

The NZIER Quarterly Survey of Business Opinion had also highlighted the intense inflation pressures in the New Zealand economy. Finding labour remained the top primary constraint for businesses in the September quarter. And despite some early signs of an easing in capacity pressures, the proportion of businesses who are passing on higher costs by raising prices remained high.   

Boosting expectations of further aggressive interest rate increases by the RBNZ 

The stronger than expected September CPI result increased market expectations that the RBNZ will raise the OCR by 75 basis points in its upcoming meeting in November. Aggressive monetary policy tightening by other central banks around the world, particularly by the US Federal Reserve, has put downward pressure on the New Zealand dollar. This in turn is driving the price of imported goods higher.  

Raising the risk of a hard landing  

The RBNZ is now expected to increase the OCR by more than previously expected, with speculation the OCR could now possibly rise above 5 percent. This could take floating mortgage rates as high as 8 percent, although fixed mortgage rates are likely to be lower than this given more competition amongst banks at lending in the 1 to 2 year fixed terms. Nonetheless, with RBNZ data showing 45 percent of fixed term mortgages are due for repricing within the coming 12 months, many of these borrowers will be facing a sharp rise in mortgage repayments as they roll off historically low fixed mortgage rates of 2 to 3 percent onto rates of over 5 percent.  

The lag in when the impact of higher interest rates become apparent on the economy highlights the risks of over-correction when conducting monetary policy. The former US Treasury Secretary Larry Summers recently couched monetary policy making as like a bad hotel shower: as the hot water takes awhile to come onstream the heat is cranked up by more and more until the water becomes scalding and has to be quickly turned down1. Time will tell how much the New Zealand economy may be scalded by over the coming year.