This morning Statistics NZ released its latest update on NZ’s consumer price index (CPI).

Prices faced by domestic consumers were shown to have increased by 0.1% in the three months to the end of December, to be 1.6% higher over the year. That remains below the middle of the 1-3% target band for inflation set in the Reserve Bank’s contract with the government.

By itself, 1.6% inflation might suggest that there is no imminent need for higher official interest rates in NZ.

However, there are several observations from the report that indicate increasing price pressures in the domestic economy.

Firstly, prices for tradable goods actually fell over the quarter, by 0.5%, to be 0.3% lower over the year. These represent 44% of the total CPI basket, and reflect items that can be imported/exported and are priced on international markets. Looking at non-tradables, prices were up by 0.5% over the quarter, and rose by 2.9% compared to December 2012. This is the highest annual increase for non-tradables since 2009 (excluding the impact of the GST increase in December 2010), and reflects a tightening demand and supply situation for domestic goods and services.

Secondly, the NZ house price boom is becoming increasingly evident in the CPI. Prices for housing and household utilities rose by 0.5% in the quarter, and are now 3.2% up over the year. Within this, the cost of a newly built house rose by 4.7% over the year, the highest increase since the second quarter of 2008.

Back then, the official cash rate was at 8.25%, compared to 2.5% now.

Finally, there is a clear, increasing trend in prices overall. The 1.6% rise in consumer prices in the year to December is the highest for two years, and is notably faster than the 0.9% rate that prevailed back in December 2012. This is important because of the strong momentum in consumer prices within an economy – once prices start rising, it tends to lead other businesses and workers to seek higher pricing for their services.

All of this indicates that the official cash rate needs to increase from its current record low level of 2.5%.

This should not come as a surprise to investors, as the Reserve Bank and other commentators have increasingly been advising of the need for higher interest rates for some time as our local economy has gathered speed.

At Milford we expect a series of 0.25% increases in the official cash rate this year, to take it to around 3.5% by the end of the year.

The Reserve Bank has indicated the first increase could occur in March.  However there is a good chance they will act sooner and increase the cash rate next week at their meeting on 31 January.

David Lewis

Portfolio Manager