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Inflation — a false signal

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Inflation — a false signal.

I'd hazard a guess that inflation isn't something most people spend a lot of time thinking about.

That's probably because on a daily basis inflation in New Zealand is quite hard to spot. For example, at the mid-point of the Reserve Bank's inflation target, a $5 coffee should see its price rise less than 1 cent each month — something even the most frugal of us would struggle to pick up.

Inflation, however, plays a far bigger role in our lives than its daily impact on the cost of goods and services might suggest. This is because rising inflation, and economic growth, typically drives up the interest rate at which we borrow (i.e. mortgage rates) therefore impacting on our disposable incomes to a far greater extent.

So should you be concerned that rising 'headline' inflation, which reached a six year high of 2.2% last quarter, might soon cause mortgage rates to jump? We think not and here's why.

Taking a look under the hood of the current inflation rise, it's evident that almost all of the increase over last quarter's numbers came from outsized contributions in two sub-groups — transport and food — both of which were impacted by one-off and temporary factors.

The well documented recovery of the oil price is now behind us, and should its price remain unchanged from here, its effect will likely reverse course and become deflationary (the opposite of inflation) next quarter. As for food, this notoriously volatile sub-group was affected by weather and supply issues in certain vegetable categories — something we'd expect to naturally unwind over the next quarter or two.

More broadly, we see little reason to believe that inflation in New Zealand can be sustained at or above current levels. Wage growth remains low, excess capacity across the labour market is still evident, and it looks as though the consumer and housing markets are again slowing.

As we see it, inflation is unlikely to push up the cost of borrowing any time soon.

 

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