Inflation could return to targeted levels by mid-2024

Inflation will likely hit the targeted 2% level by mid-2024, economists at the country’s largest bank have predicted, as they warn of “a long and difficult battle” for the Reserve Bank against domestic inflation pressures.

Read more: How fast will inflation fall?

RBNZ has been aggressively hiking interest rates since October last year to combat surging inflation, reaching 7.3% by the June quarter this year, which ANZ believes to be the peak. The central bank has hiked the OCR to 3% so far, with wholesale interest rate markets predicting a 4.25% OCR by mid-2023, with some leaning toward a 4.5% peak.

Read next: Reserve Bank may plot track to 4.5% OCR – ANZ

ANZ’s Finn Robinson and Sharon Zollner said in an NZ Insight publication that “surging wage growth” and ongoing local cost pressures will see NZ-generated inflation “hold up around current highs” until early next year before gradually easing, interest.co.nz reported.

The ANZ economists predicted that the OCR would peak at 4% by the end of this year but said “risks are firmly tilted” towards the need for more hikes to take the OCR above 4% to swiftly put inflation under control.

“There’s certainly not much wriggle room on that front,” they said. “Even in our central forecast, inflation would have been above the 2% midpoint of the RBNZ’s target band for three years. We see risks around the outlook for both domestic (non-tradable) and global (tradable) components of inflation.”

Robinson and Zollner said the key was to distinguish between the short and medium term.

“The RBNZ’s latest estimate of the neutral OCR is 2%, but they have already said that they are revisiting their models, and some members of the monetary policy committee have given a range of 2-3% as their sense for where neutral is,” the economists said. “It’s a big deal, as changes in the neutral OCR go 1:1 into the required OCR. If the neutral OCR is 3% rather than 2%, then an OCR closer to 5% rather than 4%would be needed to deliver the monetary tightening required to bring inflation back to 2% within an acceptable timeframe, all else equal. Sounds high, but so is inflation. And it’s still well below the 8.25% OCR peak seen before the GFC (although the housing market was still in full bubble mode at that point, whereas currently house prices are falling).”

On a global perspective, the economists expect that “one-off spikes” in inflation to become more common, interest.co.nz reported.

“While COVID appears to be in retreat as a global disruptor (touch wood), geopolitical tensions continue to raise the risk of ongoing commodity price surges, or a retrenchment of global trade,” Robinson and Zollner said. “And the ongoing costs of adverse weather conditions continue to mount as climate change rolls inexorably forward. All these factors mean the era of New Zealand importing global deflation through our import prices is probably behind us.

“All in all, it’s an inflation soup out there, both domestically and internationally. We’ve seen a perfect storm of supply-side impacts through COVID-19 and the supply chain chaos it has unleashed, combined with what turned out to be overly powerful fiscal and monetary stimulus (given how unexpectedly resilient economies turned out to be over the past few years). While we are forecasting that a 4% OCR will be enough to achieve a return to 2% inflation over the next two years, there are clearly significant risks that interest rates will need to go higher to engineer a timely return to target.”

Robinson and Zollner summed up the situation by saying that it’s not all one-way traffic for interest rates, but that the balance of risks remains firmly tilted towards more hikes being needed than fewer.

“While headline inflation numbers look like they may have peaked in several countries, including New Zealand, that’s not sufficient,” they told interest.co.nz. “Central banks need to ensure inflation gets all the way back to their targets, and in a reasonable timeframe (ie within a couple of years). If the process is too slow, neutral interest rates will rise significantly, and central banks could find themselves on a treadmill of ever-higher rates just to stay still in terms of the real level of tightening they are delivering.”